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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

Form 10-Q/A

(Amendment No. 2)

 

 

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 001-32590

 

 

COMMUNITY BANKERS TRUST CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		20-2652949
(State or other jurisdiction of incorporation of organization)		(I.R.S. Employer Identification No.)

 

4235 Innslake Drive, Suite 200 Glen Allen, Virginia		23060
(Address of principal executive offices)		(Zip Code)

(804) 934-9999

(Registrant’s telephone number, including area code)

not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At October 1, 2009, there were 21,468,455 shares of the Company’s common stock outstanding.

 

 

 

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EXPLANATORY NOTE

The Registrant hereby amends its Quarterly Report on Form 10-Q for the period ended September 30, 2009 (filed on November 16, 2009 with the Securities and Exchange Commission (the “Commission”)), as amended by its Quarterly Report on Form 10-Q/A (Amendment No. 1) (filed on January 14, 2011 with the Commission), as set forth in this Quarterly Report on Form 10-Q/A (Amendment No. 2).

The Form 10-Q/A (Amendment No. 2) includes revisions to the financial statements, the notes thereto and financial information in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section. As the Company disclosed in its Quarterly Report on Form 10-Q for the period ended September 30, 2010, these revisions are based on a restatement of certain information for the period ended September 30, 2009 to reflect the appropriate accounting treatment for the assets that the Registrant acquired in its acquisition of substantially all assets, and assumption of all deposit and certain other liabilities, relating to seven former branch offices of Suburban Federal Savings Bank in Maryland, based on additional information obtained during the fourth quarter of 2009. This information, which was included in the Form 10-Q for the period ended September 30, 2010, was inadvertently not updated in the Form 10-Q/A (Amendment No. 1) for the 2009 period.

As previously disclosed, and as compared to the original Form 10-Q filing, the Form 10-Q/A includes amendments to the financial statements to reflect a modified presentation of certain line items relating to the portion of the loan portfolio that is covered under shared-loss agreements with the Federal Deposit Insurance Corporation and the Registrant’s non-covered loan portfolio. This Form 10-Q/A also includes, in response to comments from the Commission, enhanced disclosure relating to goodwill and intangible assets, fair value measurements, FDIC-covered assets, asset quality and the Registrant’s acquisition of substantially all assets, and assumption of all deposit and certain other liabilities, relating to the former Suburban Federal Savings Bank.

The only items that the Registrant is amending in this Form 10-Q/A are Items 1 and 2 of Part I and Item 6 of Part II, as set forth below. The disclosures that the Registrant has presented in this Form 10-Q/A are as of the date of the original filing, and the Registrant has not undertaken to update such disclosures for any subsequent events or developments.

 

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COMMUNITY BANKERS TRUST CORPORATION

TABLE OF CONTENTS

FORM 10-Q/A

September 30, 2009

 

				Page
		PART I — FINANCIAL INFORMATION
		Item 1. Financial Statements			4
		Consolidated Statements of Financial Condition (Unaudited)			4
		Consolidated Statements of Operations (Unaudited)			5
		Consolidated Statements of Cash Flows (Unaudited)			6
		Notes to Unaudited Consolidated Financial Statements			8
		Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
		Item 3. Quantitative and Qualitative Disclosures About Market Risk			43
		Item 4. Controls and Procedures			44
		PART II — OTHER INFORMATION			46
		Item 1. Legal Proceedings			46
		Item 1A. Risk Factors			46
		Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			46
		Item 3. Defaults upon Senior Securities			46
		Item 4. Submission of Matters to a Vote of Security Holders			46
		Item 5. Other Information			46
		Item 6. Exhibits			46
		SIGNATURES			48

 

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PART I — FINANCIAL INFORMATION

Item 1.

Financial Statements

COMMUNITY BANKERS TRUST CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

AT SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

(dollars in thousands)

 

		September 30, 2009 (Unaudited) (Restated)				December 31, 2008 (Audited) (Restated)
ASSETS
Cash and due from banks		$	13,464			$	10,864
Interest bearing bank deposits			10,534				107,376
Federal funds sold			5,300				10,193
Total cash and cash equivalents			29,298				128,433
Securities available for sale, at fair value			171,184				193,992
Securities held to maturity, at cost (fair value of $124,865 and $94,965, respectively)			121,023				94,865
Equity securities, restricted, at cost			8,355				3,612
Total securities			300,562				292,469
Loans held for sale			—				200
Loans covered by FDIC shared-loss agreement (Note 9)			166,085				—
Loans excluding covered loans			569,452				523,298
Total loans			735,537				523,298
Allowance for loan losses			(16,211	)			(6,939	)
Net loans			719,326				516,359
FDIC indemnification asset (Note 10)			83,909				—
Bank premises and equipment			37,328				24,111
Other real estate owned, covered by FDIC shared-loss agreement			11,105				—
Other real estate owned, non covered			1,175				223
Bank owned life insurance			6,475				6,300
FDIC receivable for expenses incurred			3,560				—
Core deposit intangibles, net			17,645				17,163
Goodwill (Note 5)			13,152				37,184
Other assets			8,384				7,798
Total assets		$	1,231,919			$	1,030,240
LIABILITIES
Deposits:
Noninterest bearing		$	64,338			$	59,699
Interest bearing			963,191				746,649
Total deposits			1,027,529				806,348
Federal funds purchased			31				—
Federal Home Loan Bank advances			37,000				37,900
Trust preferred capital notes			4,124				4,124
Other liabilities			15,826				17,465
Total liabilities		$	1,084,510			$	865,837
STOCKHOLDERS’ EQUITY
Preferred stock (5,000,000 shares authorized $0.01 par value; 17,680 shares issued and outstanding)		$	17,680			$	17,680
Discount on preferred stock			(896	)			(1,031	)
Warrants on preferred stock			1,037				1,037
Common stock (200,000,000 shares authorized $0.01 par value; 21,468,455 shares issued and outstanding)			215				215
Additional paid in capital			143,999				146,076
Retained earnings			(16,743	)			1,691
Accumulated other comprehensive income (loss)			2,117				(1,265	)
Total stockholders’ equity		$	147,409			$	164,403
Total liabilities and stockholders’ equity		$	1,231,919			$	1,030,240

See accompanying notes to unaudited consolidated financial statements

 

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COMMUNITY BANKERS TRUST CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008

(dollars and shares in thousands, except per share data)

(unaudited)

 

		For the three months ended								For the nine months ended								BOE Predecessor For the five months ended May 31, 2008				TFC Predecessor For the five months ended May 31, 2008
		September 30, 2009				September 30, 2008				September 30, 2009				September 30, 2008
		(Restated)								(Restated)								(Note 1)				(Note 1)
Interest and dividend income
Interest and fees on non covered loans		$	8,820			$	8,497			$	26,236			$	11,201			$	6,737			$	6,849
Interest and fees on FDIC covered loans			4,152				—				11,380				—				—				—
Interest on federal funds sold			10				22				36				68				18				26
Interest on deposits in other banks			60				83				262				83				—				—
Interest and dividends on securities
Taxable			2,081				539				7,580				1,226				465				236
Nontaxable			896				333				2,473				443				555				—
Total interest income			16,019				9,474				47,967				13,021				7,775				7,111
Interest expense
Interest on deposits			6,026				2,908				18,443				3,935				3,266				3,295
Interest on federal funds purchased			2				101				6				114				21				23
Interest on other borrowed funds			338				277				1,071				357				458				—
Total interest expense			6,366				3,286				19,520				4,406				3,745				3,318
Net interest income			9,653				6,188				28,447				8,615				4,030				3,793
Provision for loan losses			5,231				1,100				11,271				1,334				200				1,348
Net interest income after provision for loan losses			4,422				5,088				17,176				7,281				3,830				2,445
Noninterest income
Service charges on deposit accounts			674				516				1,863				696				464				342
Gain on SFSB transaction			—				—				20,255				—				—				—
Gain on securities transactions, net			612				—				905				—				6				—
Gain (loss) on sale of other real estate			500				—				563				—				(92	)			—
Other			356				238				1,337				357				476				87
Total noninterest income			2,142				754				24,923				1,053				854				429
Noninterest expense
Salaries and employee benefits			4,840				2,375				14,294				2,949				2,493				3,708
Occupancy expenses			752				346				1,886				458				216				318
Equipment expenses			436				292				1,198				400				286				295
Legal fees			217				151				772				250				306				106
Professional fees			185				133				1,341				233				325				1,029
FDIC assessment			436				60				1,310				76				11				95
Data processing fees			743				285				2,217				389				394				1,917
Amortization of intangibles			565				406				1,675				555				—				—
Impairment of goodwill			—				—				24,032				—				52				—
Other operating expenses			1,765				608				5,118				1,281				799				761
Total noninterest expense			9,939				4,656				53,843				6,591				4,882				8,229
Income (loss) before income taxes			(3,375	)			1,186				(11,744	)			1,743				(198	)			(5,355	)
Income tax expense (benefit)			(1,473	)			234				3,380				392				10				1,454
Net income (loss)		$	(1,902	)		$	952			$	(15,124	)		$	1,351			$	(188	)		$	(3,901	)
Dividends accrued on preferred stock			223				—				661				—				—				—
Accretion of discount on preferred stock			47				—				135				—				—				—
Net income (loss) available to common stockholders		$	(2,172	)		$	952			$	(15,920	)		$	1,351			$	(188	)		$	(3,901	)
Net income (loss) per share — basic		$	(0.10	)		$	0.04			$	(0.74	)		$	0.09			$	(0.15	)		$	(0.85	)
Net income (loss) per share — diluted		$	(0.10	)		$	0.04			$	(0.74	)		$	0.08			$	(0.15	)		$	(0.85	)
Weighted average number of shares outstanding
basic			21,468				21,469				21,468				14,750				1,214				4,587
diluted			21,468				21,486				21,468				16,197				1,214				4,587

See accompanying notes to unaudited consolidated financial statements

 

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COMMUNITY BANKERS TRUST CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(unaudited)

 

		For the nine months ended								BOE Predecessor For the five months ended May 31, 2008				TFC Predecessor For the five months ended May 31, 2008
		September 30, 2009				September 30, 2008
		(Restated)								(Note 1)				(Note 1)
Operating activities:
Net income (loss)		$	(15,124	)		$	1,351			$	(188	)		$	(3,901	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and intangibles amortization			3,130				750				335				240
Provision for loan losses			11,271				1,334				200				1,348
Amortization of premiums and accretion of discounts, net			1,141				54				36				(13	)
Change in loans held for sale			200				721				(119	)			—
Net gain on SFSB transaction			(20,255	)			—				—				—
Impairment of goodwill			24,032				—				52				—
Stock-based compensation expense			—				—				—				178
Net (gain) on sale of securities			(905	)			—				(6	)			—
Net (gain) on sale of OREO			(563	)			—				92				—
Net loss/(gain) on sale of loans			13				(15	)			(90	)			—
Loss on write down of LLC membership			—				—				88				—
Changes in assets and liabilities:
(Increase)/decrease in other assets			124				(3,108	)			(409	)			(1,285	)
Increase/(decrease) in accrued expenses and other liabilities			(5,017	)			(3,190	)			897				2,874
Net cash provided by (used in) by operating activities			(1,683	)			(2,103	)			888				(559	)
Investing activities:
Proceeds from securities			147,928				65,131				2,364				12,605
Purchase of securities			(143,244	)			(23,489	)			(3,350	)			(7,205	)
Cash received from SFSB transaction			54,717				10,016				—				—
Net increase in loans, excluding covered loans			(49,105	)			(28,641	)			(11,870	)			(37,358	)
Net decrease in loans covered by shared loss agreement			32,168				—				—				—
Purchase of premises and equipment, net			(14,634	)			(989	)			(523	)			(164	)
Net cash provided by (used in) by investing activities			27,830				22,028				(13,379	)			(32,122	)
Financing activities:
Net increase/ (decrease) in noninterest bearing and interest bearing demand deposits			(81,575	)			(5,693	)			11,789				28,536
Net increase/(decrease) in federal funds purchased			31				(1,095	)			1,965				5,218
Issuance of common stock			—				—				56				—
Cash paid to shareholders for converted shares			—				(10,843	)			—				—
Cash paid to reduce FHLB borrowings			(38,425	)			20,000				900				—
Cash paid to redeem shares related to asserted appraisal rights and retire warrants			(2,077	)			(11	)			—				—
Cash dividends paid			(3,236	)			(861	)			(535	)			(1,152	)
Net cash (used in) provided by financing activities			(125,282	)			1,497				14,175				32,602
Net (decrease) increase in cash and cash equivalents			(99,135	)			21,422				1,684				(79	)
Cash and cash equivalents:
Beginning of the period			128,433				162				4,100				4,311
End of the period		$	29,298			$	21,584			$	5,784			$	4,232
Supplemental disclosures of cash flow information:
Interest paid		$	20,686			$	4,689			$	3,902			$	3,195
Income taxes paid			296				—				127				—
Transfers of OREO property			952				224
Transactions related to acquisition
Increase in assets and liabilities:
Loans, net		$	198,253			$	471,864
Other real estate owned			9,416				—
Securities			4,954				71,123
FDIC indemnification asset			84,584				—
Fixed assets, net			37				—
Other assets			10,332				83,769
Deposits			302,756				491,462
Borrowings			37,525				32,359
Other liabilities			1,757				8,861

See accompanying notes to unaudited consolidated financial statements

 

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COMMUNITY BANKERS TRUST CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

General

Community Bankers Trust Corporation (the “Company”) is a bank holding company that was incorporated under Delaware law on April 6, 2005. The Company is headquartered in Glen Allen, Virginia and is the holding company for Essex Bank (the “Bank”), a Virginia state bank with 25 full-service offices in Virginia, Maryland and Georgia. Bank of Essex changed its name to Essex Bank on April 20, 2009.

The Company was initially formed as a special purpose acquisition company to effect a merger, capital stock exchange, asset acquisition or other similar business combination with an operating business in the banking industry. Prior to its acquisition of two bank holding companies in 2008, the Company’s activities were limited to organizational matters, completing its initial public offering and seeking and evaluating possible business combination opportunities. On May 31, 2008, the Company acquired each of TransCommunity Financial Corporation, a Virginia corporation (“TFC”), and BOE Financial Services of Virginia, Inc., a Virginia corporation (“BOE”). The Company changed its corporate name in connection with the acquisitions. On November 21, 2008, the Bank acquired certain assets and assumed all deposit liabilities relating to four former branch offices of The Community Bank (“TCB”), a Georgia state-chartered bank. On January 30, 2009, the Bank acquired certain assets and assumed all deposit liabilities relating to seven former branch offices of Suburban Federal Savings Bank, Crofton, Maryland (“SFSB”).

The Bank was established in 1926 and is headquartered in Tappahannock, Virginia. The Bank engages in a general commercial banking business and provides a wide range of financial services primarily to individuals and small businesses, including individual and commercial demand and time deposit accounts, commercial and consumer loans, travelers checks, safe deposit box facilities, investment services and fixed rate residential mortgages. Fourteen offices are located in Virginia, primarily from the Chesapeake Bay to just west of Richmond, seven are located in Maryland along the Baltimore-Washington corridor and four are located in the Atlanta, Georgia metropolitan market.

The consolidated statements presented include accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts have been eliminated. In the opinion of management, the accompanying financial statements contain all adjustments necessary to fairly present the financial position of the Company at each of September 30, 2009 and December 31, 2008. The statements should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K/A (Amendment No. 3) for the year ended December 31, 2008. In the opinion of management, all adjustments (consisting of normal accruals) were made that are necessary to present fairly the financial position of the Company at September 30, 2009, and the results of its operations and its cash flows for the three and nine months ended September 30, 2009 and 2008.

The statements and related notes have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) are not presented pursuant to such rules and regulations, because the periods reported are not comparable.

Predecessors

From its inception until consummation of the acquisitions of TFC and BOE on May 31, 2008, the Company was a special purpose acquisition company, as described above, and had no substantial operations. Accordingly, since the Company’s operating activities prior to the acquisitions were insignificant relative to those of TFC and BOE, management believes that both TFC and BOE are the Company’s predecessors. Management has reached this conclusion based upon an evaluation of facts and circumstances, including the historical life of each of TFC and BOE, the historical level of operations of each of TFC and BOE, the purchase price paid for each of TFC and BOE and the fact that the consolidated Company’s operations, revenues and expenses after the acquisitions are most similar in all respects to those of BOE’s and TFC’s historical periods. Accordingly, the historical statements of operations for the five months ended May 31, 2008 and statements of cash flows for the five months ended May 31, 2008 of each of TFC and BOE have been presented.

 

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2. ACCOUNTING POLICIES

The accounting and reporting policies of the Company conform to GAAP and to the general practices within the banking industry. The interim financial statements have not been audited; however, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the consolidated financial statements have been included. Operating results for the three and nine month period ended September 30, 2009, are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

During 2008, management discovered that there was an error in the fair value of stock options issued by the Company in settlement of the TFC and BOE stock options outstanding as of the respective merger dates. When correcting this valuation error, the adjustment was inadvertently recorded twice. The result was an understatement of Goodwill and Deferred Taxes Liabilities of approximately $2.9 million and $1.5 million, respectively. An adjustment has been made to correct this error and the financial statements for the year ended December 31, 2008 have been restated.

The September 30, 2009 consolidated financial statements and accompanying notes have been restated for amendments to the original estimated values related to the acquisition of the Maryland operations.

Certain reclassifications have been made to prior period balances to conform to the current period presentation.

The Company’s financial statements are prepared in accordance with GAAP. The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that the Company uses. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact its transactions could change. In preparing the financial statements, the Company has evaluated events and transactions occurring subsequent to the financial statement date through the filing date of November 16, 2009 for potential recognition or disclosure.

3. RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) became effective on July 1, 2009. At that date, the ASC became FASB’s officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. The adoption of FASB ASC had no impact on the Company’s consolidated financial statements.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157) (ASC 820 Fair Value Measurements and Disclosures). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather, provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. The Company adopted SFAS 157 on January 1, 2008. The FASB approved a one-year deferral for the implementation of the Statement for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company adopted the provisions of SFAS 157 for nonfinancial assets and liabilities as of January 1, 2009 without a material impact on the consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)) (ASC 805 Business Combinations). The Standard significantly changed the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes principles for how an acquirer recognizes and measures the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisition dates on or after the beginning of an entity’s first year that begins after December 15, 2008. The Company adopted the provisions of SFAS 141(R) with respect to the SFSB acquisition.

In April 2009, the FASB issued FASB Staff Position (FSP) on Statement No. 141(R)-1 (FSP FAS 141(R)-1), “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (ASC 805 Business Combinations). FSP FAS 141(R)-1 amends and clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company adopted the provisions of SFAS 141(R) with respect to the SFSB acquisition.

 

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In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (ASC 820 Fair Value Measurements and Disclosures). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. The FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. Earlier adoption is permitted for periods ending after March 15, 2009. The Company does not expect the adoption of FSP FAS 157-4 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASC 825 Financial Instruments and ASC 270 Interim Reporting). FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. In addition, the FSP amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. The Company does not expect the adoption of FSP FAS 107-1 and APB 28-1 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (ASC 320 Investments – Debt and Equity Securities). FSP FAS 115-2 and FAS 124-2 amend other-than-temporary impairment guidance for debt securities to make guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 and FAS 124-2 are effective for interim and annual periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. The Company does not expect the adoption of FSP FAS 115-2 and FAS 124-2 to have a material impact on its consolidated financial statements.

In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (SAB 111). SAB 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities.” SAB 111 maintains the SEC Staff’s previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. The Company does not expect the implementation of SAB 111 to have a material impact on its consolidated financial statements.

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, “Subsequent Events” (ASC 855 Subsequent Events). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. The Company does not expect the adoption of SFAS 165 to have a material impact on its consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” (ASC 860 Transfers and Servicing). SFAS 166 provides guidance to improve the relevance, representational faithfulness, and comparability of the information that a report entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. SFAS 166 is effective for interim and annual periods ending after November 15, 2009. The Company does not expect the adoption of SFAS 166 to have a material impact on its consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (ASC 810 Consolidation). SFAS 167 improves financial reporting by enterprises involved with variable interest entities. SFAS 167 is effective for interim and annual periods ending after November 15, 2009. Early adoption is prohibited. The Company does not expect the adoption of SFAS 167 to have a material impact on its consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – replacement of FASB Statement No. 162” (ASC 105 Generally Accepted Accounting Principles). SFAS 168 establishes the FASB Accounting Standards Codification which will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. SFAS 168 is effective immediately. The Company does not expect the adoption of SFAS 168 to have a material impact on its consolidated financial statements.

 

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In June 2009, the FASB issued EITF Issue No. 09-1, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing” (ASC 470 Debt). EITF Issue No. 09-1 clarifies how an entity should account for an own-share lending arrangement that is entered into in contemplation of a convertible debt offering. EITF Issue No. 09-1 is effective for arrangements entered into on or after June 15, 2009. Early adoption is prohibited. The Company does not expect the adoption of EITF Issue No. 09-1 to have a material impact on its consolidated financial statements.

In June 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 112 (SAB 112). SAB 112 revises or rescinds portions of the interpretative guidance included in the codification of SABs in order to make the interpretive guidance consistent with current U.S. GAAP. The Company does not expect the adoption of SAB 112 to have a material impact on its consolidated financial statements.

In August 2009, the FASB issued Accounting Standards Update No. 2009-05 (ASU 2009-05), “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value.” ASU 2009-05 amends Subtopic 820-10, “Fair Value Measurements and Disclosures – Overall,” and provides clarification for the fair value measurement of liabilities. ASU 2009-05 is effective for the first reporting period including interim period beginning after issuance. The Company does not expect the adoption of ASU 2009-05 to have a material impact on its consolidated financial statements.

In September 2009, the FASB issued Accounting Standards Update No. 2009-12 (ASU 2009-12), “Fair Value Measurements and Disclosures (Topic 820): Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” ASU 2009-12 provides guidance on estimating the fair value of alternative investments. ASU 2009-12 is effective for interim and annual periods ending after December 15, 2009. The Company does not expect the adoption of ASU 2009-12 to have a material impact on its consolidated financial statements.

In October 2009, the FASB issued Accounting Standards Update No. 2009-15 (ASU 2009-15), “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The Company does not expect the adoption of ASU 2009-15 to have a material impact on its consolidated financial statements.

4. MERGERS AND ACQUISITIONS

Business Combinations

On May 31, 2008, the Company acquired each of TFC and BOE. The transaction with TFC was valued at $53.0 million. Total consideration paid to TFC shareholders consisted of 6,544,840 shares of the Company’s common stock issued. The transaction resulted in total assets acquired at May 31, 2008 of $268.8 million, including $241.9 million of loans, and liabilities assumed were $241.7 million, including $232.1 million of deposits. The transaction with BOE was valued at $53.9 million. Total consideration paid to BOE shareholders consisted of 6,957,405 shares of the Company’s common stock issued. This transaction resulted in total assets acquired at May 31, 2008 of $317.6 million, including $233.3 million of loans, and liabilities assumed were $288.0 million, including $256.4 million of deposits. Due to the mergers with each of TFC and BOE, the Company recorded approximately $37.2 million in goodwill and $15.0 million in core deposit intangibles as of May 31, 2008.

Immediately following the mergers with TFC and BOE, the Company operated TransCommunity Bank and the Bank as separate banking subsidiaries. TransCommunity Bank’s offices operated under the Bank of Goochland, Bank of Powhatan, Bank of Louisa and Bank of Rockbridge division names. Effective July 31, 2008, TransCommunity Bank was consolidated into the Bank under the Bank’s state charter. As a result, the Company was a one-bank holding company at the September 30, 2008 reporting date.

Acquisition of Georgia Operations

On November 21, 2008, the Bank acquired certain assets and assumed all deposit liabilities relating to four former branch offices of The Community Bank (“TCB”), a Georgia state-chartered bank. The transaction was consummated pursuant to a Purchase and Assumption Agreement, dated November 21, 2008, by and among the Federal Deposit Insurance Corporation (“FDIC”), as Receiver for The Community Bank, Bank of Essex and the FDIC. Management evaluated the applicability of Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”, as well as EITF 98-3 “Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business” in determining the accounting for this transaction. Based upon an assessment of the transaction, management determined that there were significant limitations on the resources transferred and, therefore, concluded that the net assets acquired did not meet the definition of a “Business” as required by these authoritative standards. Accordingly, the transaction was accounted for as an asset purchase.

 

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Pursuant to the terms of the Purchase and Assumption Agreement, the Bank assumed approximately $619.0 million in deposits, approximately $233.9 million of which were deemed to be core deposits, and paid the FDIC a premium of 1.36% on the core deposits amounting to approximately $3.2 million. All deposits insured prior to the closing of the transaction maintained their current insurance coverage.

The Company also acquired assets of $87.5 million as follows (dollars in thousands):

 

Cash and cash equivalents		$	54,439
Investment securities			31,304
Loans and accrued interest			1,593
Other assets			135
Total assets		$	87,471

The loans acquired were those fully secured by deposit accounts. The Bank did not purchase any additional loans as of December 31, 2008.

The Bank had 60 days to evaluate and, at its sole option, purchase any of the remaining TCB loans. As a result, the Bank purchased 175 loans totaling approximately $21 million on January 9, 2009. Also, the Bank had 90 days to evaluate and, at its sole option, purchase the premises and equipment. The Bank agreed to purchase all four former banking premises of TCB for $6.4 million on February 19, 2009.

Acquisition of Maryland Operations

On January 30, 2009, the Bank acquired certain assets and assumed all deposit liabilities relating to seven former branch offices of Suburban Federal Savings Bank, Crofton, Maryland. The transaction was consummated pursuant to a Purchase and Assumption Agreement, dated January 30, 2009, by and among the FDIC, as Receiver for SFSB, the Bank and the FDIC.

Pursuant to the terms of the Purchase and Assumption Agreement, the Bank assumed approximately $303 million in deposits, all of which were deemed to be core deposits and maintain their current insurance coverage. The Bank also acquired approximately $362 million in loans and other assets and agreed to provide loan servicing to SFSB’s existing loan customers. The Bank bid a negative $45 million for the net assets acquired.

The Bank has entered into shared-loss agreements with the FDIC with respect to certain covered assets acquired. See Notes 9 and 10 for additional information related to certain assets covered under the FDIC shared-loss agreements.

In relation to this acquisition, the Company followed the acquisition method of accounting as outlined in SFAS 141(R), “Business Combinations”. Management relied on external analyses by appraisers in determining the fair value of assets acquired and liabilities assumed. The following table provides the allocation of the negative bid in the financial statements, based on those analyses (dollars in thousands):

 

		SFSB
Negative bid on SFSB transaction		$	45,000
Adjustments to assets acquired and liabilities assumed:
Fair value adjustments:
Loans			(102,011	)
Foreclosed real estate			(10,428	)
FDIC indemnification			84,584
Deposits			(1,455	)
Core deposit intangible			2,158
Other adjustments			(2,407	)
Net assets acquired, pre-tax			20,255
Deferred tax liability			(6,886	)
Net assets acquired, net of tax		$	13,369

 

 

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Fair value of assets acquired
Cash and cash equivalents		$	54,717
Investment securities			4,954
Loans receivable			198,253
Foreclosed real estate			9,416
FDIC indemnification asset			84,584
Other assets			10,369
Fair value of assets acquired		$	362,293
Fair value of liabilities assumed
Deposits		$	302,756
FHLB advances			37,525
Deferred taxes			6,886
Other liabilities			1,757
Fair value of liabilities assumed		$	348,924
Net assets acquired at fair value		$	13,369

As a result of the acquisition of the operations of SFSB, the Company recorded a one-time gain of $20.3 million in the first quarter of 2009.

The Company engaged two external firms to assess credit quality and fair market value of the loan portfolio. An external firm performed a 100% credit review on the entire portfolio and classified each of the loans into several homogenous pools of credit risk and levels of impairment. An external firm specializing in fair market valuations then used the credit review results to determine the current fair market as defined in SFAS No. 157, “Fair Value Measurements” (ASC 820 Fair Value Measurements and Disclosures). The fair value assessment was based on several measures, including asset quality, contractual interest rates, current market interest rates, and other underlying factors and the analysis divided the portfolio into the following segments:

 

•

Acquisition, development, and construction loans

 

•

Residential first mortgage loans

 

•

Consumer real estate loans

 

•

Commercial real estate loans

The following three general approaches were used in the valuation analyses – the asset-based approach, the market approach, and the income approach.

Certificate of deposits (CDs) and the core deposit intangible (premium paid to acquire the core deposits of SFSB) were marked to market using a third-party analysis of cash flow, interest rate, maturity dates or weighted average life, balances, attrition rates, and current market rates.

The Company reviewed certain contracts between SFSB and its vendors in order to identify any efficiencies from the merger through contract cancellation. The costs of cancelling certain contracts were not material enough to change the amount of the gain recorded.

Supplemental pro forma information reflecting the revenue and earnings of the combined entity for the current reporting period as though the acquisition date for the business combination had occurred at the beginning of the annual reporting period, and similar comparative information for the prior year, has not been disclosed. Management has determined that it is impracticable to provide this information due to a lack of reliability of financial information produced by SFSB prior to the acquisition and the costs that would be incurred to reproduce the information with an appropriate level of reliability.

5. GOODWILL AND INTANGIBLE ASSETS

The Company follows SFAS 142, Goodwill and Other Intangible Assets, which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. Provisions within SFAS 142 discontinue any amortization of goodwill and intangible assets with indefinite lives, and require at least an annual impairment review or more often if certain impairment conditions exist. With the TFC and BOE mergers consummated May 31, 2008, there were significant amounts of goodwill and other intangible assets recorded. Goodwill was assessed for potential impairment as of May 31, 2009, the anniversary date of the mergers.

 

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Since the mergers in 2008, there has been further decline in economic conditions, which has significantly affected the banking sector and the Company’s financial condition and results. The Company’s average closing stock price during the second quarter of 2008 and 2009 was $6.64 per share and $3.67 per share, respectively, which represented a 44.73% decline. On the last business day prior to May 31, 2009, the closing stock price was $3.10 per share. The average closing stock price for the third quarter of 2009 was $3.41.

The initial step in identifying potential impairment involves comparing the current fair value of such goodwill to its recorded or carrying amount. If the carrying value exceeds such fair value, there is possible impairment. Next, a second step is performed to determine the amount of the impairment, if any. This step requires a comparison of the Company’s book value to the fair value of its assets, liabilities, and intangibles. If the carrying amount of goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess. Management retained a business valuation expert to assist in determining the level and extent to which goodwill was impaired. The Company determined that goodwill was impaired as of May 31, 2009, and a $24.0 million impairment charge was recorded during the second quarter of 2009. Because the acquisitions were considered tax-free exchanges, the goodwill impairment charge cannot be deducted for tax purposes, and as such, an income tax benefit cannot be recorded. Due to this tax treatment, the goodwill impairment charge will be reflected as a permanent difference in the deferred tax calculation.

In determining the goodwill impairment charge, the reporting unit was defined as “Community Bankers Trust Corporation,” as the Company has determined that it has no reportable segments or “components” of a segment, as defined in SFAS No. 142, “Goodwill and Other Intangible Assets” (ASC 350 Intangibles – Goodwill and Other).

The Company used and weighted two valuation methods in determining the fair value of the reporting unit – the guideline transaction method and the discounted cash flow method. The guideline transaction method uses actual change-of-control transactions involving entities similar to the reporting unit. These transactions consist of merger and acquisition transactions involving financial institutions, and the Company derived the fair value of the reporting unit based on the price/tangible book value multiples and core deposit premiums reported in these transactions. The Company used this method as it reflects the guidance in SFAS No. 142, which is consistent with SFAS No. 157, that “the estimate of fair value shall be based on the best information available, including prices for similar assets and liabilities . . . .”

The discounted cash flow analysis relies upon a projection of future cash flows, the present value of which represents the value of the reporting unit. Management supplied projections of the reporting unit’s future balance sheets and income statements, which were used in the analysis. Under the discounted cash flow method, the value of the reporting unit is the sum of the distributable cash flows generated by the reporting unit and a terminal value in 2013 representing the value of all future cash flows. The Company used the discounted cash flow method because market participants commonly use discounted cash flow analyses in acquisitions of financial institutions, as the value of an enterprise is equal to its future cash flows. Further, SFAS No. 142 indicates that, “A present value technique is often the best available technique with which to estimate the fair value of a group of net assets (such as a reporting unit) . . . .”

The Company then compared the conclusion of value indicated by the preceding valuation methods to the Company’s market capitalization and the valuation multiples for a group of comparable publicly traded banks to the Company.

In determining a conclusion of value for the reporting unit, the guideline transactions method received two-thirds of the total weight (split equally between the indications of value based on tangible book value and core deposits), and the discounted cash flow method received one-third of the total weighting. This weighting methodology reflects that actual transactions involving enterprises with similar characteristics to the subject reporting unit provide the most meaningful indication of value. The Company weighted the discounted cash flow method as it is commonly employed in the financial services industry and represents a value based on the future cash flows generated by the reporting unit.

The material assumptions used and the sensitivity in them for the two valuation methods used are as follows:

 

•

The guideline transactions method derives the fair value of the reporting unit using (a) the reporting unit’s tangible book value and core deposits at May 31, 2009 and (b) multiples of tangible book value and core deposits derived from marketplace transactions, as reported by SNL Financial. The multiples were derived from two groups of transactions – (a) transactions announced between June 1, 2008 and May 31, 2009 involving banks located nationwide with assets greater than $250 million and (b) transactions announced between June 1, 2008 and May 31, 2009 involving banks and thrifts located in the Mid-Atlantic region. A change in the price/tangible book value multiple by 10% would affect the value by a like amount. A change in the core deposit premium by 10% would affect the value by approximately 2%.

 

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•

The discounted cash flow method relies upon a projection of the reporting unit’s future financial performance, including assumptions as to its future balance sheet growth, asset composition, funding mix, asset quality, capital levels, net interest income, non-interest income, non-interest expenses, loan loss provision, income taxes, and distributable cash flows. In addition, the discounted cash flow method requires a terminal value, which reflects the value of the reporting unit after the end of the finite forecast period. The terminal value is a function of the reporting unit’s projected 2013 net income and tangible book value, and multiples of net income and tangible book value. The Company then discounts the projected future cash flows and terminal value to the present at a discount rate derived from marketplace assumptions as to returns demanded on equity investments.

 

•

Particularly significant assumptions in the discounted cash flow method include (a) the reporting unit’s future net income and distributable cash flows, (b) the terminal multiple of earnings or tangible book value, and (c) the discount rate.

Goodwill will be next assessed for potential impairment as of December 31, 2009, as management determined that goodwill will be evaluated in the future on an annual basis coinciding with the end of the fiscal year, unless economic or other circumstances warrant evaluations at additional times.

During 2008, management discovered that there was an error in the fair value of stock options issued by the Company in settlement of the TFC and BOE stock options outstanding as of the respective merger dates. When correcting this valuation error, the adjustment was inadvertently recorded twice. The result was understatement of Goodwill and Deferred Taxes Liabilities of approximately $2.9 million and $1.5 million, respectively. An adjustment has been made to correct this error and the financial statements for the year ended December 31, 2008 have been restated.

Core deposit intangible assets are amortized over the period of expected benefit, ranging from 2.6 to 9 years. Core deposit intangibles are recognized, amortized and evaluated for impairment as required by SFAS No. 142, “Goodwill and Other Intangible Assets” (ASC 350 Intangibles – Goodwill and Other). Due to the mergers with TFC and BOE on May 31, 2008, the Company recorded approximately $15.0 million in core deposit intangible assets. Core deposit intangibles related to the Georgia and Maryland transactions equaled $3.1 million and $2.2 million, respectively, and will be amortized over approximately 9 years.

Goodwill and core deposit intangible assets are presented in the following table:

 

		Gross Amount Value				Accumulated Amortization				Impairment				Net Carrying Value
						(dollars in thousands)
December 31, 2008
Goodwill (restated)		$	37,184				—				—			$	37,184
Core deposit intangibles		$	18,132			$	969				—			$	17,163
September 30, 2009
Goodwill		$	37,184				—			$	24,032			$	13,152
Core deposit intangibles		$	20,290			$	2,645				—			$	17,645

6. FAIR VALUE MEASUREMENTS

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, trading securities and derivatives, if present, are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

 

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Fair Value Hierarchy

Under FASB ASC 820, “Fair Value Measurements and Disclosures”, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 — Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value each reporting period. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company only utilizes third party vendors to provide fair value data for purposes of recording amounts related to the fair value measurements of its securities available for sale portfolio. An AICPA Statement on Auditing Standard Number 70 (SAS 70) report is obtained from the third party vendor on an annual basis. The third party vendor also utilizes a reputable pricing company for security market data. The third party vendor has controls and edits in place for month-to month market checks and zero pricing. The Company makes no adjustments to the pricing service data received for its securities available for sale.

Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 would include asset-backed securities in less liquid markets.

Loans held for sale

Loans held for sale are recorded at the lower of cost or fair value each reporting period, and are comprised of residential mortgages. These loans are held for a short period of time with the intention of being sold on the secondary market. Therefore, the fair value is determined on rates currently offered using observable market information, which does not deviate materially from the cost value. If there are any adjustments to record the loan at the lower of cost of market value, it would be reflected in the consolidated statements of income. It was determined that the cost value recorded at September 30, 2009 was similar to the fair value, and therefore no adjustment was necessary. Due to the observable market data available in pricing these loans held for sale, they were considered as Level 2.

Loans, excluding covered loans (noncovered)

Except for loans that the Company acquired in the SFSB transaction, the Company does not record unimpaired loans held for investment at fair value each reporting period. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Bank frequently obtains appraisals prepared by external professional appraisers for classified loans greater than $250,000 when the most recent appraisal is greater than 12 months old. The appraisal, based on the date of preparation, becomes only a part of the determination of the amount of any loan write-off, with current market conditions and the collateral’s location being other determinants. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2.

The Bank may also identify collateral deterioration based on current market sales data, including price and absorption, as well as input from real estate sales professionals and developers, county or city tax assessments, market data and on-site inspections by Bank personnel. Internally prepared estimates generally result from current market data and actual sales data related to the Bank’s collateral or where the collateral is located. When management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. In instances where an appraisal received subsequent to an internally prepared estimate reflects a higher collateral value, management does not revise the carrying amount.

Reviews of classified loans are performed by management on a quarterly basis. At September 30, 2009, substantially all of the impaired loans were evaluated based on the fair value of the collateral.

Loans covered by FDIC shared-loss agreement (covered)

Fair values for loans were based on a discounted cash flow methodology that considered various factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing. Loans were pooled together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The discount rate used for loans are based on the rates used at acquisition (which were based on market rates for new originations of comparable loans) and have been adjusted since acquisition based on how changes in expected cash flows have changed future accretable yield. The discount rate does not include a factor for credit losses as that has been included in the estimated cash flows.

Other real estate owned (non covered)

Other real estate owned (OREO), including foreclosed assets, is adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the OREO as a nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Other real estate owned, covered by FDIC shared-loss agreement

Other real estate owned (OREO), covered by FDIC shared-loss agreement (covered) is adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, it is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the OREO as a nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

FDIC indemnification asset

These loss sharing assets are measured separately from the related covered assets as they not contractually embedded in the assets and are not transferable with the assets should the Company choose to dispose of them. Fair value was estimated using projected cash flows related to the loss sharing agreements based on the expected reimbursements for losses and the applicable loss sharing percentages. These expected reimbursements do not include reimbursable amounts related to future covered expenditures. These cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss haring reimbursement from the FDIC.

Goodwill

See Note 5 for a description of valuation methodologies for goodwill.

 

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Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.

 

		September 30, 2009
		Total				Level 1				Level 2				Level 3
		(dollars in thousands)
Investment securities available-for-sale:
U.S. Treasury issue and U.S. government agencies		$	16,103			$	—			$	16,103			$	—
State, county, and municipal			94,034				—				94,034				—
Corporates and other bonds			2,834				—				2,834				—
Mortgage backed securities			56,857				—				56,857				—
Financial stocks			1,356				1,356				—				—
Total securities available-for-sale			171,184				1,356				169,828				—
Loans covered by FDIC shared-loss agreement			166,085				—				—				166,085
FDIC indemnification asset			83,909				—				—				83,909
Total assets at fair value		$	421,178			$	1,356			$	169,828			$	249,994
Total liabilities at fair value		$	—			$	—			$	—			$	—

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These assets include assets that are measured at the lower of cost value or market value that were recognized at fair value below cost at the end of the period. The table below presents the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis.

 

		September 30, 2009
		Total				Level 1				Level 2				Level 3
		(dollars in thousands)
Loans — impaired loans with a valuation allowance		$	26,776			$	—			$	24,202			$	2,574
Other real estate owned (OREO), covered by FDIC shared-loss agreement			11,105				—				2,620				8,485
Other real estate owned (OREO), non covered			1,175				—				1,175				—
Goodwill			13,152				—				—				13,152
Total assets at fair value		$	52,208			$	—			$	27,997			$	24,211
Total liabilities at fair value		$	—			$	—			$	—			$	—

The Company had no Level 1 assets measured at fair value on a nonrecurring basis at September 30, 2009.

 

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ASC 820, “Fair Value Measurements and Disclosures”, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. ASC 820 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Short-Term Investments

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities

For securities held for investment purposes, fair values are based on quoted market prices or dealer quotes.

Restricted Securities

The carrying value of restricted securities approximates their fair value based on the redemption provisions of the respective entity.

Loans Receivable

For certain homogeneous categories of loans, such as some residential mortgages, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposit Liabilities

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Long-Term Borrowings

The fair values of the Corporation’s long-term borrowings are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of stand-by letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

At September 30, 2009, the fair values of loan commitments and stand-by letters of credit were deemed to be immaterial.

 

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The fair values and carrying values are as follows:

 

		September 30, 2009
(dollars in thousands)		Carrying Value				Fair Value
Financial assets:
Cash and cash equivalents		$	29,298			$	29,315
Securities available for sale			171,184				171,184
Securities held to maturity			121,023				124,883
Equity securities			8,355				8,355
Loans, non covered, net			553,241				546,242
Loans covered by FDIC shared-loss agreement			166,085				166,085
FDIC indemnification asset			83,909				83,909
Accrued interest receivable			5,401				5,401
Financial liabilities:
Deposits			1,027,529				1,033,024
Borrowings			41,155				46,035
Accrued interest payable			3,159				3,159

The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Corporation’s overall interest rate risk.

7. SECURITIES

Amortized costs and fair values of securities available for sale at September 30, 2009 were as follows:

 

(dollars in thousands)		Amortized Cost				Gross Unrealized								Fair Value
						Gains				Losses
U.S. Treasury issue and other U.S. Government agencies		$	15,589			$	514			$	—			$	16,103
State, county and municipal			90,976				3,275				(217	)			94,034
Corporates and other bonds			2,761				73				—				2,834
Mortgage backed securities			55,392				1,469				(4	)			56,857
Other securities			1,293				165				(102	)			1,356
Total securities available for sale		$	166,011			$	5,496			$	(323	)		$	171,184

 

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The fair value and gross unrealized losses for securities available for sale, totaled by the length of time that individual securities have been in a continuous gross unrealized loss position, at September 30, 2009 were as follows:

 

(dollars in thousands)		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
State, county and municipal		$	2,075			$	(193	)		$	2,204			$	(24	)		$	4,279			$	(217	)
Mortgage backed securities			710				(4	)			—				—				710				(4	)
Other securities			1,092				(96	)			12				(6	)			1,104				(102	)
Total securities available for sale		$	3,877			$	(293	)		$	2,216			$	(30	)		$	6,093			$	(323	)

At September 30, 2009, there were $2.2 million of securities available for sale that were in a continuous loss position for more than twelve months with unrealized losses of $30,000 and consisted primarily of municipal obligations. Management continually monitors the fair value and credit quality of the Company’s investment portfolio. Furthermore, a third party vendor prepares a report for other than temporarily impaired evaluations. Management reviews this report monthly, and there were no investments considered other than temporarily impaired at September 30, 2009.

Amortized costs and fair values of securities held to maturity at September 30, 2009 were as follows:

 

(dollars in thousands)		Amortized Cost				Gross Unrealized								Fair Value
						Gains				Losses
U.S. Treasury issue and other U.S. Government agencies		$	748			$	—			$	(1	)		$	747
State, county and municipal			13,104				859				—				13,963
Corporates and other bonds			1,030				26				—				1,056
Mortgage backed securities			106,141				3,078				(102	)			109,117
Total securities held to maturity		$	121,023			$	3,963			$	(103	)		$	124,883

The fair value and gross unrealized losses for securities held to maturity, totaled by the length of time that individual securities have been in a continuous gross unrealized loss position, at September 30, 2009 were as follows:

 

(dollars in thousands)		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
U.S. Treasury issue and other U.S. Government agencies		$	748			$	(1	)		$	—			$	—			$	748			$	(1	)
Mortgage backed securities			10,501				(102	)			—				—				10,501				(102	)
Total securities held to maturity		$	11,249			$	(103	)		$	—			$	—			$	11,249			$	(103	)

Management continually monitors the fair value and credit quality of the Company’s investment portfolio. At September 30, 2009, all impairments of securities held to maturity are considered temporary as the unrealized losses are related to market risk and not credit risk. The Company does not intend to sell the securities and it is not likely that the company will be required to sell the security before recovery of its amortized cost. Issuers of the securities held to maturity and available for sale are of suitable credit quality and all of the securities are of investment grade.

The Company’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $3.6 million at September 30, 2009. FHLB stock is restricted since it is not actively traded on an exchange, and is owned solely by the FHLB and its member institutions. The Company records FHLB stock on a cost basis. When evaluating FHLB stock for impairment, its value is based on recovery of the par value rather than by recognizing temporary decline in value. While the FHLB temporarily suspended dividend payments on its stock and repurchases of excess capital stock during 2009, it declared an annualized dividend rate of 0.41% for the third quarter of 2009, which is scheduled for payment in November 2009.

 

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8. LOANS EXCLUDING COVERED LOANS

The Company’s loan portfolio, segregated by loans covered by the FDIC shared-loss agreement (Covered Loans) and loans not covered by this agreement (Non-covered Loans), at September 30, 2009 and December 31, 2008, was comprised of the following (dollars in thousands):

 

		September 30, 2009 Non-covered loans								December 31, 2008 Total Loans
Open End 1-4 Family Loans		$	31,008				5.44	%		$	30,323				5.80	%
1-4 Family First Liens			107,882				18.94	%			99,284				18.98	%
Total residential 1-4 family			138,890				24.38	%			129,607				24.78	%
Owner occupied nonfarm nonresidential			81,810				14.36	%			63,218				12.09	%
Non owner occupied nonfarm nonresidential			105,182				18.47	%			93,872				17.95	%
Total commercial			186,992				32.83	%			157,090				30.03	%
1-4 Family Construction			28,811				5.06	%			36,277				6.93	%
Other construction and land development			111,708				19.61	%			103,238				19.74	%
Total construction			140,519				24.67	%			139,515				26.67	%
Second mortgages			14,124				2.48	%			15,599				2.98	%
Multifamily			10,757				1.89	%			9,370				1.79	%
Agriculture			3,907				0.69	%			5,143				0.98	%
Total real estate loans			495,189				86.94	%			456,324				87.23	%
Agriculture loans			1,407				0.25	%			988				0.19	%
Commercial and industrial loans			45,348				7.96	%			44,332				8.48	%
Total commercial loans			46,755				8.21	%			45,320				8.67	%
Total revolving credit and other consumer			15,927				2.79	%			14,457				2.76	%
All other loans			11,706				2.06	%			7,005				1.34	%
Gross loans			569,577				100.00	%			523,106				100.00	%
Unearned income on loans			(785	)							(780	)
Merger related fair value adjustment			660								972
Total non-covered loans		$	569,452							$	523,298

The following is a summary of information for impaired and nonaccrual loans at September 30, 2009, excluding FDIC covered assets (dollars in thousands):

 

		Amount
Impaired loans without a valuation allowance		$	27,728
Impaired loans with a valuation allowance			26,776
Total impaired loans		$	54,504
Valuation allowance related to impaired loans		$	9,454
Total nonaccrual loans		$	20,572
Total loans 90 days or more past due and still accruing		$	1,462
Average investment in impaired loans during the nine months ending September 30, 2009		$	43,001
Interest income recognized on impaired loans		$	919
Interest income recognized on a cash basis on impaired loans		$	919

See Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset Quality for additional information regarding impaired loans.

 

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9. COVERED ASSETS

The Company is applying the provisions of FASB ASC 310 to all loans acquired in the SFSB acquisition (the “covered loans”).

The following table reflects the contractual cash flows, cash flows expected at acquisition, and fair value of loans as of the acquisition date. These amounts were determined based upon the estimated remaining life of the covered loans, which includes the effects of prepayments.

 

(In Thousands)		Total Loans
Contractually required principal and interest at acquisition		$	431,081
Nonaccretable difference (expected losses of $99,648 and foregone interest of $72,157)			171,805
Cash flows expected to be collected at acquisition		$	259,276
Accretable yield (interest component of expected cash flows)			61,023
Basis in acquired loans at acquisition		$	198,253

As of January 1, 2009 there were no covered loans. As of September 30, 2009, the outstanding balance of the covered loans accounted for under FASB ASC 31-30 is $262,379. The carrying amount as of September 30, 2009 is comprised of the following.

 

(Dollars in Thousands)		September 30, 2009 Covered Loans
Open End 1-4 Family Loans		$	8,131				4.90	%
1-4 Family First Liens			117,472				70.73	%
Total residential 1-4 family			125,603				75.63	%
Owner occupied nonfarm nonresidential			—				0.00	%
Non owner occupied nonfarm nonresidential			6,566				3.95	%
Total commercial			6,566				3.95	%
1-4 Family Construction			7,309				4.40	%
Other construction and land dev.			17,178				10.34	%
Total construction			24,487				14.74	%
Second mortgages			8,957				5.40	%
Multifamily			—				0.00	%
Agriculture			240				0.14	%
Total real estate loans			165,853				99.86	%
Agriculture loans							0.00	%
Commercial and industrial loans			—				0.00	%
Total commercial loans			—				0.00	%
Total revolving credit and other consumer			232				0.14	%
Total covered loans		$	166,085				100.00	%

 

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The change in the accretable yield balance since January 1, 2009 is as follows:

 

		Accretable Yield
Balance at January 1, 2009		$	—
Additions			61,023
Less Accretion			(11,380	)
Reclassification from (to) Nonaccretable Yield			—
Balance at September 30, 2009		$	49,643

These loans are not classified as nonperforming assets at September 30, 2009 as the loans are accounted for on a pooled basis and the pools are considered to be performing. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, is being recognized on all purchased loans. There was no allowance for loan losses recorded on covered loans at December 31, 2009.

10. SHARED-LOSS AGREEMENTS AND FDIC INDEMNIFICATION ASSET

On January 30, 2009, the Company entered into a purchase and assumption agreement with shared-loss with the FDIC to assume all of the deposits and acquire certain assets of Suburban Federal Savings Bank. Under the shared-loss agreements, the FDIC will reimburse the Bank for 80% of losses arising from covered loans and foreclosed real estate assets, on the first $118 million of such covered loans and foreclosed real estate assets, and for 95% of losses on covered loans and foreclosed real estate assets thereafter. Under the shared-loss agreements, a “loss” on a covered loan or foreclosed real estate is defined generally as a realized loss incurred through a permitted disposition, foreclosure, short-sale or restructuring of the covered loan or foreclosed real estate. The reimbursements for losses on single family one-to-four residential mortgage loans are to be made monthly until the end of the month in which the tenth anniversary of the closing of the transaction occurs, and the reimbursements for losses on other covered assets are to be made quarterly until the end of the quarter in which the eighth anniversary of the closing of the transaction occurs. The shared-loss agreements provide for indemnification from the first dollar of losses without any threshold requirement. The reimbursable losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the transaction, January 30, 2009. New loans made after that date are not covered by the shared-loss agreements. The fair value of this loss sharing agreement is detailed below.

The Company is accounting for the shared-loss agreements as an indemnification asset pursuant to the guidance in FASB ASC 805 Business Combinations. The FDIC indemnification asset is measured separately from the covered loans and other real estate owned assets because it is not contractually embedded in the covered loan and other real estate owned assets and is not transferable should the Company choose to dispose of them. Fair value was estimated using projected cash flows available for loss sharing based on the credit adjustments estimated for each loan pool and OREO and the loss sharing percentages outlined in the Purchase and Assumption Agreements with the FDIC. These cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss sharing reimbursement from the FDIC.

Because the acquired loans are subject to a FDIC loss sharing agreement and a corresponding Indemnification Asset exists to represent the value of expected payments from the FDIC, increases and decreases in loan accretable yield due to loss expectations will also have an impact to the accretable yield for the FDIC indemnification asset. Improvement in loss expectations will typically increase loan accretable yield and decrease the yield on the FDIC indemnification asset, and in some instances, result in an amortizable premium on the FDIC indemnification asset. Increases in loss expectations will typically be recognized as impairment in the current period through allowance for loan losses while resulting in additional non-interest income for the amount of the increase in the FDIC indemnification asset.

 

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The following tables present the balances of the FDIC indemnification asset related to the Suburban Federal Savings Bank transaction at January 30, 2009 (the transaction date) and September 30, 2009:

 

(In Thousands)		January 30, 2009
Anticipated realizable loss		$	108,756
Assumed loss sharing recovery percentage			approximately 80	%
Estimated loss sharing value			86,988
Premium (discount)			(2,404	)
FDIC indemnification asset		$	84,584
		September 30, 2009
Anticipated realizable loss remaining			107,289
Assumed loss sharing recovery percentage			approximately 80	%
Estimated loss sharing value			85,831
Premium (discount)			(1,922	)
FDIC indemnification asset		$	83,909

 

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11. ALLOWANCE FOR LOAN LOSSES

Activity in the allowance for loan losses, for the three and nine months ended September 30, 2009; the four months ended September 30, 2008 and the five months ended May 31, 2008 Predecessor period was comprised of the following:

 

(dollars in thousands)		Three months  ended September 30, 2009				Nine Months  ended September 30, 2009				Four Months ended September 30, 2008				BOE Predecessor Five Months ended May 31, 2008				TFC Predecessor Five Months ended May 31, 2008
Beginning allowance		$	12,185			$	6,939			$	5,305			$	2,595			$	3,036
Provision for loan losses			5,231				11,271				1,334				200				1,348
Recoveries of loans charged off			224				306				36				25				—
Loans charged off			(1,429	)			(2,305	)			(128	)			(91	)			(958	)
Allowance at end of period		$	16,211			$	16,211			$	6,547			$	2,729			$	3,426

For information reported for September 30, 2008, the figures presented are solely for the months of June 2008 through September 2008, as the Company did not have banking operations prior to its merger with each of TFC and BOE at May 31, 2008 and, as such, did not have an allowance for loan losses. Predecessor periods for the five months ended May 31, 2008 are shown above.

At September 30, 2009, total impaired loans equaled $54.5 million, excluding FDIC covered assets. As required by the fair value accounting rules for the SFSB transaction in the first quarter of 2009, no allowance for loan losses was recorded on loans acquired since the loans were recorded at fair value and adjusted for expected credit losses, less amounts to be reimbursed by the FDIC. For additional information regarding the accounting entries, see the Company’s Current Report on Form 8-K/A (Amendment No. 1) filed on April 17, 2009, under Note 2 — Description of the Pro Forma Purchase Accounting Adjustments.

Significant provisions were made to the loan loss reserve during the nine months ended September 30, 2009, as economic conditions deteriorated. In addition, net-charge off activity increased as certain loans were deemed uncollectible.

 

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The following table presents charge-offs and recoveries by loan category for the three and nine months ended September 30, 2009, the four months ended September 30, 2008, and for Predecessor companies for the five months ended May 31, 2008.

 

																																						BOE Predecessor												TFC Predecessor
		For the three months ended September 30, 2009												For the nine months ended September 30, 2009												For the four months ended September 30, 2008												For the five months ended May 31, 2008												For the five months ended May 31, 2008
(dollars in thousands)		Charge- offs				Recoveries				Net Charge- offs				Charge- offs				Recoveries				Net Charge- offs				Charge- offs				Recoveries				Net Charge- offs				Charge- offs				Recoveries				Net Charge- offs				Charge- offs				Recoveries				Net Charge- offs
Open End 1-4 Family loans		$	—			$	—			$	—			$	168			$	—			$	168			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
1-4 Family First Liens			—				—				—				108				—				108				—				—				—				—				—				—				—				—				—
Total residential 1-4 family			—				—				—				276				—				276				—				—				—				—				—				—				—				—				—
Owner occupied nonfarm nonresidential			814				—				814				814				—				814				—				—				—				—				—				—				—				—				—
Non owner occupied nonfarm nonresidential			—				—				—				—				—				—				—				—				—				—				—				—				—				—				—
Total commercial			814				—				814				814				—				814				—				—				—				—				—				—				—				—				—
1-4 Family Construction			—				183				(183	)			61				199				(138	)			—				—				—				—				—				—				—				—				—
Other construction and land development			583				—				583				591				—				591				—				—				—				—				—				—				70				—				70
Total construction			583				183				400				652				—				453				—				—				—				—				—				—				70				—				70
Second mortgages			—				—				—				34				—				34				—				—				—				—				—				—				—				—				—
Multifamily			—				—				—				—				—				—				—				—				—				—				—				—				—				—				—
Agriculture			—				—				—				13				—				13				—				—				—				—				—				—				—				—				—
Total real estate loans			1,397				183				1,214				1,789				199				1,590				—				—				—				—				—				—				70				—				70
Agriculture loans			—				—				—				—				—				—				—				—				—				—				—				—				—				—				—
Commercial and industrial loans			—				17				(17	)			318				20				298				—				—				—				—				5				(5	)			835				—				835
Total commercial loans			—				17				(17	)			318				20				298				—				—				—				—				5				(5	)			835				—				835
Total revolving credit and other consumer			4				11				(7	)			170				74				96				128				36				92				91				20				71				53				—				53
All other loans			28				13				15				28				13				15				—				—				—				—				—				—				—				—				—
Total non-covered loans		$	1,429			$	224			$	1,205			$	2,305			$	306			$	1,999			$	128			$	36			$	92			$	91			$	25			$	66			$	958			$	—			$	958

 

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12. DEPOSITS

The following table provides interest-bearing deposit information by category for the dates indicated:

 

Balance by deposit type		September 30, 2009				December 31, 2008
		(dollars in thousands)
NOW		$	88,045			$	76,575
MMDA			110,353				55,200
Savings			58,495				34,688
Time deposits less than $100,000			450,273				303,424
Time deposits greater than $100,000			256,025				276,762
Total interest-bearing deposits		$	963,191			$	746,649

13. (LOSS) EARNINGS PER SHARE

Basic (loss) earnings per share (“EPS”) is computed by dividing net income or loss available to common stockholders by the weighted average number of shares outstanding during the period. Diluted EPS is computed using the weighted average number of common shares outstanding during the period, including the effect of all potentially dilutive potential common shares outstanding attributable to stock instruments.

 

(dollars and shares in thousands, except per share data)		(Loss)/ Income (Numerator)				Weighted Average Shares (Denominator)				Per Share Amount
For the Three Months ended September 30, 2009
Basic EPS		$	(2,172	)			21,468			$	(0.10	)
Effect of dilutive stock awards and options			—				—				—
Diluted EPS		$	(2,172	)			21,468			$	(0.10	)
For the Three Months ended September 30, 2008
Basic EPS		$	952				21,469			$	0.04
Effect of dilutive stock awards and options			—				17				—
Diluted EPS		$	952				21,486			$	0.04
For the Nine Months ended September 30, 2009
Basic EPS		$	(15,920	)			21,468			$	(0.87	)
Effect of dilutive stock awards and options			—				—				—
Diluted EPS		$	(15,920	)			21,468			$	(0.87	)
For the Nine Months ended September 30, 2008
Basic EPS		$	1,351				14,750			$	0.09
Effect of dilutive stock awards and options			—				1,447				(0.01	)
Diluted EPS		$	1,351				16,197			$	0.08

There were 5,249,256 shares in the Company available through options and warrants that were considered anti-dilutive at September 30, 2009.

 

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BOE Predecessor (Dollars and shares in thousands, except per share data)		(Loss)  Income (Numerator)				Weighted Average Shares (Denominator)				Per Share Amount
For the five months ended May 31, 2008
Basic EPS		$	(188	)			1,214			$	(0.15	)
Effect of dilutive stock awards			—				—				—
Diluted EPS		$	(188	)			1,214			$	(0.15	)

 

TFC Predecessor (Dollars and shares in thousands, except per share data)		(Loss)  Income (Numerator)				Weighted Average Shares (Denominator)				Per Share Amount
For the five months ended May 31, 2008
Basic EPS		$	(3,901	)			4,587			$	(0.85	)
Effect of dilutive stock awards			—				—				—
Diluted EPS		$	(3,901	)			4,587			$	(0.85	)

14. DEFINED BENEFIT PLAN

The Company adopted the Bank noncontributory, defined benefit pension plan for all full-time, pre-merger Bank employees over 21 years of age at May 31, 2008. Benefits are generally based upon years of service and the employees’ compensation. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

Components of Net Periodic Benefit Cost:

 

		Nine Months Ended September 30, 2009				Nine Months Ended September 30, 2008				BOE Predecessor Five Months Ended May 31, 2008				TFC Predecessor Five Months Ended May 31, 2008
		(In thousands)				(In thousands)
Service cost		$	276			$	164			$	155				Not applicable
Interest cost			243				135				128
Expected return on plan assets			(159	)			(140	)			(133	)
Amortization of prior service cost			3				2				2
Amortization of net obligation at transition			(3	)			(2	)			(2	)
Amortization of net loss			66				8				7
Net periodic benefit cost		$	426			$	166			$	157

At September 30, 2009, employer contributions totaled $264,000 for the plan year. The Company is currently analyzing the Defined Benefit Plan as well as other alternatives, such as enhancing its Defined Contribution Plan (401(k)). The plan was frozen to new entrants prior to BOE’s merger with the Company.

15. SUBSEQUENT EVENTS

On October 29, 2009, the Company’s Board of Directors declared a quarterly dividend of $0.04 per share with respect to the Company’s outstanding common stock. The dividend will be payable on November 20, 2009, to stockholders of record at the close of business on November 13, 2009.

 

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of the financial condition at September 30, 2009 and results of operations of the Company for the three and nine months ended September 30, 2009 should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in this report and in the Company’s Annual Report on Form 10-K/A (Amendment No. 3) for the year ended December 31, 2008.

Overview

Community Bankers Trust Corporation (the “Company”) is a bank holding company that was incorporated under Delaware law on April 6, 2005. The Company is headquartered in Glen Allen, Virginia and is the holding company for Essex Bank, a Virginia state bank with 25 full-service offices in Virginia, Maryland and Georgia.

The Bank was established in 1926 and is headquartered in Tappahannock, Virginia. The Bank engages in a general commercial banking business and provides a wide range of financial services primarily to individuals and small businesses, including individual and commercial demand and time deposit accounts, commercial and consumer loans, travelers checks, safe deposit box facilities, investment services and fixed rate residential mortgages. Fourteen branches are located in Virginia, primarily from the Chesapeake Bay to just west of Richmond, seven are located in Maryland along the Baltimore-Washington corridor and four are located in the Atlanta, Georgia metropolitan market. The Bank also operates two loan production offices, one in Fairfax, Virginia, and one in Cumming, Georgia.

The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. The Company’s cost of funds is a function of the average amount of interest-bearing deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses. Additionally, the Bank earns non-interest income from service charges on deposit accounts and other fee or commission-based services and products. Other sources of non-interest income can include gains or losses on securities transactions, gains from loans sales, transactions involving bank-owned property, and income from Bank Owned Life Insurance (“BOLI”) policies. The Company’s income is offset by non-interest expense, which consists of goodwill impairment and other charges, salaries and benefits, occupancy and equipment costs, professional fees, and other operational expenses. The provision for loan losses and income taxes materially affect income.

Caution About Forward-Looking Statements

The Company makes certain forward-looking statements in this Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.

These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors, including, without limitation, the effects of and changes in the following:

 

•

general economic and market conditions, either nationally or locally;

 

•

the interest rate environment;

 

•

competitive pressures among banks and financial institutions or from companies outside the banking industry;

 

•

real estate values;

 

•

the quality or composition of the Company’s loan or investment portfolios;

 

•

the demand for deposit, loan, and investment products and other financial services;

 

•

the demand, development and acceptance of new products and services;

 

•

the timing of future reimbursements from the FDIC to the Company under the shared-loss agreements;

 

•

consumer profiles and spending and savings habits;

 

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•

the securities and credit markets;

 

•

the integration of banking and other internal operations, and associated costs

 

•

management’s evaluation of goodwill and other assets on a periodic basis, and any resulting impairment charges, under applicable accounting standards;

 

•

the soundness of other financial institutions with which the Company does business;

 

•

inflation;

 

•

technology; and

 

•

legislative and regulatory requirements.

These factors and additional risks and uncertainties are described in the “Risk Factors” discussion in Part II, Item 1A, of this report.

Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

Critical Accounting Policies

The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions and judgments.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses (“ALLL”) is maintained at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. Since arriving at an appropriate ALLL involves a high degree of management judgment, an ongoing quarterly analysis to develop a range of estimated losses is utilized. In accordance with accounting principles generally accepted in the United States, best estimates within the range of potential credit loss to determine the appropriate ALLL is utilized. Credit losses are charged and recoveries are credited to the ALLL.

The Company utilizes an internal risk rating system for its loans. Those larger credits that exhibit probable or well defined credit weaknesses are subject to individual review. The borrower’s cash flow, adequacy of collateral coverage, and other options available to the Company, including legal remedies, are evaluated. The review of individual loans includes those loans that are impaired as defined by SFAS 114, Accounting by Creditors for Impairment of a Loan. Collectability of both principal and interest when assessing the need for loss provision is considered. Historical loss rates are applied to other loans not subject to specific allocations. The loss rates are determined from historical net charge offs experienced by the Bank.

Historical loss rates for commercial and retail loans are adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors that are considered include delinquency trends, current economic conditions and trends, strength of supervision and administration of the loan portfolio, levels of underperforming loans, level of recoveries to prior year’s charge offs, trend in loan losses, industry concentrations and their relative strengths, amount of unsecured loans and underwriting exceptions. These factors are reviewed quarterly and a weighted score is assigned depending on the level and extent of the risk. The total of each of these weighted factors is then applied against the applicable portion of the portfolio and the ALLL is adjusted to ensure an appropriate level.

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that the Company uses. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact its transactions could change.

 

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Loans Acquired in a Transfer

The Company’s acquired loans from the SFSB acquisition (the “covered loans”), subject to FASB ASC Topic 805, Business Combinations (formerly SFAS 141(R)), are recorded at fair value and no separate valuation allowance is recorded at the date of acquisition. FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (formerly SOP 03-3) applies to loans acquired with evidence of deterioration of credit quality since origination acquired by completion of transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. The Company is applying the provisions of FASB ASC 310-30 to all loans acquired in the Suburban Federal Savings Bank acquisition, not just the loans acquired with evidence of deterioration of credit quality since origination acquired by completion of transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. The Company has grouped loans together based on common risk characteristics including product type, delinquency status and loan documentation requirements among others.

The Company makes an estimate of the total cash flows it expects to collect from a pool of loans, which includes undiscounted expected principal and interest. The excess of that amount over the fair value of the pool is referred to as accretable yield. Accretable yield is recognized as interest income on a constant yield basis over the life of the pool. The Company also determines each pool’s contractual principal and contractual interest payments. The excess of that amount over the total cash flows it expects to collect from the pool is referred to as nonaccretable difference, which is not accreted into income. Judgmental prepayment assumptions are applied to both contractually required payments and cash flows expected to be collected at acquisition. Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected. Subsequent increases in expected or actual cash flows are first used to reverse any existing valuation allowance for that loan or pool. Any remaining increase in cash flows expected to be collected is recognized as an adjustment to the accretable yield with the amount of periodic accretion adjusted over the remaining life of the pool. Subsequent decreases in cash flows expected to be collected over the life of the pool are recognized as impairment in the current period through allowance for loan loss.

Income Taxes

The Company follows tax guidance, including the Financial Accounting Standards Board’s (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes (SFAS 109). In determining the appropriate level of income taxes to be recorded each reporting, management assesses the potential tax effects and records those amounts in both current and deferred tax accounts, whether may be an asset or liability. In addition, an income tax expense or benefit is determined, which is recorded on the consolidated income statement.

Goodwill and Other Intangible Assets

The Company adopted SFAS 142, Goodwill and Other Intangible Assets. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value-based test. As a result of the mergers with each of TFC and BOE at May 31, 2008, goodwill was initially recorded for $39.5 million. Subsequently, adjustments were recorded to properly reflect goodwill on the financial statements. The Company assessed goodwill for impairment as of the one year anniversary date of the mergers, at May 31, 2009.

During 2008, management discovered that there was an error in the fair value of stock options issued by the Company in settlement of the TFC and BOE stock options outstanding as of the respective merger dates. When correcting this valuation error, the adjustment was inadvertently recorded twice. The result was an understatement of Goodwill and Deferred Taxes Liabilities of approximately $2.9 million and $1.5 million, respectively. An adjustment has been made to correct this error and the financial statements for the year ended December 31, 2008 have been restated.

The initial step in identifying potential impairment involves comparing the current fair value of such goodwill to its recorded or carrying amount. If the carrying value exceeds such fair value, there is possible impairment. Next, a second step is performed to determine the amount of the impairment, if any. This requires a comparison of the Company’s book value to the fair value of its assets, liabilities, and intangibles. If the carrying amount of goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess. The Company determined that goodwill was impaired as of May 31, 2009, and a $24.0 million impairment charge was recorded during the second quarter of 2009. The goodwill impairment charge was due to an overall decline in general economic conditions, rapid change in the market valuations of financial institutions and the discount that shares of the Company’s common stock have traded to their tangible book value for an extended period of time.

 

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Additionally, under SFAS 142, acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the assets can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful lives. Branch acquisition transactions were outside the scope of SFAS 142 and, accordingly, intangible assets related to such transactions continued to amortize upon the adoption of SFAS 142. The costs of purchased deposit relationships and other intangible assets, based on independent valuation by a qualified third party, are being amortized over their estimated lives. Core deposit intangible amortization expense charged to operations was $565,000 and $1.7 million for the three and six months ended September 30, 2009, respectively. The Company did not record any goodwill or other intangible prior to the TFC and BOE mergers. As a result of the TCB and SFSB transactions, core deposit intangibles were recorded of $3.2 million and $2.2 million, respectively. Also related to the SFSB transaction during the first quarter of 2009 was a gain of $16.2 million ($10.7 million, net of taxes), which was recorded as a one-time gain within the income statement.

Financial Condition

At September 30, 2009, the Company had total assets of $1.232 billion, an increase of $201.7 million or 19.58% from December 31, 2008. Total loans, excluding FDIC covered assets, equaled $569.5 million at September 30, 2009, increasing $46.2 million, or 8.82% from December 31, 2008. Securities totaled $300.6 million and increased $8.1 million, or 2.77% during the first nine months of 2009. The Company had federal funds sold of $5.3 million at September 30, 2009, versus $10.2 million at year-end 2008, a decrease of $4.9 million or 48.00%. The shift in the earning asset mix as evidenced above is the direct result of management’s intention of replacing relatively lower yielding overnight funds with higher yielding assets of loans and securities.

The increase in the total asset size of the Company was primarily due to the SFSB transaction in Maryland. At September 30, 2009, FDIC covered loans equaled $166.1 million, FDIC covered other real estate owned equaled $11.1 million, the FDIC indemnification asset was $83.9 million and the FDIC receivable equaled $3.6 million. Securities from SFSB were incorporated into the Company’s securities portfolio at fair value at the effective time of the transaction, and are not considered covered assets under the terms of the FDIC shared-loss agreements.

The Company is required to account for the effect of market changes in the value of securities available-for-sale (“AFS”) under SFAS 115. The market value of the September 30, 2009 AFS portfolio was $171.2 million at September 30, 2009, and the net unrealized gain on the AFS portfolio was $3.9 million, net of taxes, and included as part of the Company’s accumulated other comprehensive income of $2.1 million. Since December 31, 2008, the AFS portfolio shifted from a net unrealized loss of $700,000 to a net unrealized gain of $5.2 million, exclusive of taxes over the first nine months of 2009. The Company deems the investment portfolio as a viable source of liquidity given the dollar volume of securities designated available for sale.

Total deposits at September 30, 2009 were $1.028 billion, which increased $221.2 million or 27.43% from December 31, 2008. Deposit growth was attributed to the SFSB transaction, which was concentrated in certificates of deposit. At September 30, 2009, total deposits in our Maryland branches aggregated $279.3 million of which $208.8 million were time deposits. Interest-bearing deposits increased $216.5 million from December 31, 2008 to September 30, 2009. Noninterest-bearing deposits, in the form of demand deposit accounts, were $64.3 million at September 30, 2009, an increase of $4.6 million since December 31, 2008. The Company’s total loans-to-deposits ratio, excluding FDIC covered loans, was 55.42% at September 30, 2009 and 64.90% at December 31, 2008.

Stockholders’ equity at September 30, 2009 was $147.4 million and represented 11.96% of total assets. Stockholders’ equity was $164.4 million, or 15.97% of total assets at December 31, 2008.

Results of Operations

Net Income

For the three months ended September 30, 2009, net loss before dividends and accretion on preferred stock was $1.9 million, compared with net income of $952,000 for the same period in 2008. Net loss available to common stockholders was $2.2 million, which represented $0.10 per share on a fully diluted basis, versus net income available to common stockholders of $952,000, or $0.04 per share on a fully diluted basis for the same period in 2008. The loss incurred during the third quarter of 2009 was primarily the result of a $5.2 million provision for loan losses, compared to $1.1 million in provisions during the same period in 2008.

For the nine months ended September 30, 2009, net loss before dividends and accretion on preferred stock was $15.1 million, compared with net income $1.4 million for the same period in 2008. Net loss available to common stockholders was $15.9 million, which represented $0.74 per share on a fully diluted basis, versus net income available to common stockholders of $1.4 million, or $0.08 per share on a fully diluted basis for the same period in 2008. Net loss for the nine months ended September 30, 2009, was driven by the goodwill impairment charge of $24.0 million and loan loss provisions of $11.3 million. While the $20.3 million gain recorded on the SFSB transaction in the first quarter partially offset these large expenses, the goodwill impairment charge does not reduce taxable income and permit an income tax benefit.

 

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Net Interest Income

The Company’s results of operations are significantly affected by its ability to manage effectively the interest rate sensitivity and maturity of its interest-earning assets and interest-bearing liabilities. At September 30, 2009, the Company’s interest-earning assets exceeded its interest-bearing liabilities by approximately $47.6 million, compared with a $144.7 million excess at December 31, 2008.

Net interest income was $9.7 million for the three months ended September 30, 2009, compared with $6.2 million for the same period in 2008. For the three months ended September 30, 2009, the net interest margin was 3.78% compared to 4.26% for the same period in 2008. For the three months ended September 30, 2009, the net interest spread was 3.67% versus 3.70% for the same period in 2008. The decline in the margin compared with the same period in 2008 was driven by several factors. First, loan rates declined in the fourth quarter of 2008 due to a prime rate drop. There was also a large influx of deposits related to TCB transaction in the fourth quarter of 2008 which were subsequently invested in securities versus higher yielding loans. In addition, the SFSB transaction resulted in further margin compression during 2009 as the Bank inherited a large volume of FDIC covered non-accruing loans that are included in the margin calculation.

With the acquisitions of TFC and BOE in May 2008, fair market value adjustments were recorded for assets and liabilities, including interest bearing loans and interest bearing deposits. However, the amortization of the fair value adjustments for those deposits significantly reduced interest expense during the third quarter of 2008, far in excess of reductions in interest income associated with the amortization of the fair value adjustments for loans. As a result, the net interest margin for the third quarter of 2008 was more positively influenced when compared with the third quarter of 2009.

For the nine months ended September 30, 2009, net interest income aggregated $28.4 million, which generated a net interest margin of 3.64%. The net interest spread for the nine months ended September 30, 2009 equaled 3.50%. A net interest margin analysis is not provided for the nine months ended September 30, 2008, since there were no banking operations for the Company for the first five months of 2008.

 

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Components used in determining the net interest spread and the net interest margin, including yields on assets and costs of funds by category, are depicted in the following table:

COMMUNITY BANKERS TRUST CORPORATION

NET INTEREST MARGIN ANALYSIS

AVERAGE BALANCE SHEETS

 

		Three months ended September 30
		2009												2008
		Average Balance Sheet				Interest Income/ Expense				Average Rates Earned/Paid				Average Balance Sheet				Interest Income/ Expense				Average Rates Earned/Paid
ASSETS:
FDIC covered loans, including fees		$	172,050			$	4,152				9.65	%		$	496,803			$	8,497				6.84	%
Loans non covered, including fees			559,547				8,820				6.31	%
Total loans			731,597				12,972				7.09	%			496,803				8,497				6.84	%
Interest bearing bank balances			11,061				60				2.17	%			9,384				83				3.54	%
Federal funds sold			20,905				10				0.19	%			5,034				22				1.75	%
Investments (taxable)			216,277				2,081				3.85	%			50,809				539				4.24	%
Investments (tax exempt)(1)			91,927				1,358				5.91	%			35,068				505				5.76	%
Total earning assets			1,071,767				16,481				6.15	%			597,098				9,646				6.46	%
Allowance for loan losses			(13,290	)											(5,380	)
Non-earning assets			193,267												90,098
Total assets		$	1,251,744											$	681,816
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand -
Interest bearing		$	200,965			$	381				0.76	%		$	84,032			$	328				1.56	%
Savings			58,438				100				0.68	%			31,126				84				1.08	%
Time deposits			724,191				5,545				3.06	%			314,585				2,495				3.17	%
Total deposits			983,594				6,026				2.45	%			429,743				2,907				2.71	%
Fed funds purchased			1,126				2				0.71	%			17,408				101				2.32	%
FHLB and other borrowings			40,005				338				3.38	%			28,974				277				3.82	%
Total interest-bearing liabilities			1,024,725				6,366				2.48	%			476,125				3,285				2.76	%
Non-interest bearing deposits			61,269												54,060
Other liabilities			19,000												7,410
Total liabilities			1,104,994												537,595
Stockholders’ equity			146,750												144,221
Total liabilities and stockholders’ equity		$	1,251,744											$	681,816
Net interest earnings						$	10,115											$	6,361
Interest spread											3.67	%											3.70	%
Net interest margin											3.78	%											4.26	%

 

(1)	Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%.

 

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COMMUNITY BANKERS TRUST CORPORATION

NET INTEREST MARGIN ANALYSIS

AVERAGE BALANCE SHEETS

 

		Nine months ended September 30, 2009
		Average Balance Sheet				Interest Income/ Expense				Average Rates Earned/Paid
ASSETS:
FDIC covered loans, including fees		$	162,476			$	11,380				9.34	%
Loans non covered, including fees			547,578				26,236				6.39	%
Total loans			710,054				37,616				7.06	%
Interest bearing bank balances			23,332				262				1.50	%
Federal funds sold			20,914				36				0.23	%
Investments (taxable)			250,738				7,580				4.03	%
Investments (tax exempt) (1)			84,255				3,747				5.93	%
Total earning assets			1,089,293				49,241				6.03	%
Allowance for loan losses			(10,484	)
Non-earning assets			194,924
Total assets		$	1,273,733
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand -
Interest bearing		$	193,998			$	1,556				1.07	%
Savings			54,733				374				0.91	%
Time deposits			734,653				16,513				3.00	%
Total deposits			983,384				18,443				2.50	%
Fed funds purchased			1,085				6				0.74	%
FHLB and other borrowings			43,415				1,071				3.29	%
Total interest-bearing liabilities			1,027,884				19,520				2.53	%
Non-interest bearing deposits			61,313
Other liabilities			26,041
Total liabilities			1,115,238
Stockholders’ equity			158,495
Total liabilities and stockholders’ equity		$	1,273,733
Net interest earnings						$	29,721
Interest spread											3.50	%
Net interest margin											3.64	%

 

(1)	Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%.

 

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Provision for Credit Losses

For the three months ended September 30, 2009, the Company’s provision for loan losses was $5.2 million compared with $1.1 million in the same period of 2008. For the nine months ended September 30, 2009, provisions were $11.3 million compared with $1.3 million in the same period of 2008.

Significant increases were made to the loan loss reserve during the third quarter of 2009 as economic conditions continued to show signs of deterioration, which necessitated further provisions for impairments of classified assets. The most notable impetus for the provision was evidenced in one borrowing relationship which was previously impaired and on the Bank’s watch list. Current information related to unwinding the credit necessitated further impairment which amounted to nearly 50% of the provision for the quarter. This loan was commercial/residential land development and was originated approximately 10 years ago with real estate as collateral. The amount outstanding was $7.2 million at both June 30, 2009 and September 30, 2009. The allowance allocated to this loan was $650 at June 30, 2009 and $3.0 million at September 30, 2009. There were no charge-offs during these quarters related to this loan. The loan was placed on non-accrual statues during June of 2009. The last appraisal was in April of 2009 for $9 million. Other evaluation procedures included discussions with professionals knowledgeable with similar developments and potential buyers and sellers. The remaining balance of the provision during the third quarter was attributable to downgraded credits and further insulation from the economic downturn. Management continues to monitor the loan portfolio closely and make appropriate adjustments using the Company’s internal risk rating system.

While the Maryland loan portfolio contains significant risk, it was considered in determining the initial fair value, which was reflected in adjustments recorded at the time of the SFSB transaction, less the FDIC guaranteed portion of losses on covered assets. Net-charge off activity has increased during recent quarters, a trend that is expected to continue until weakening economic conditions begin to subside. Please refer to the Asset Quality discussion below for further analysis.

Noninterest Income

For the three months ended September 30, 2009, noninterest income was $2.1 million, compared with $754,000 in the same period of 2008. This increase of $1.4 million or 184.08% is primarily attributable to gains on securities transactions of $612,000 and gains on the sale of other real estate of $500,000 versus no gains in either category in the same period of 2008. Increased service charges on deposit accounts of $158,000 and an increase in other noninterest income of $118,000 over the same period in 2008 accounted for the remainder of the increase.

For the nine months ended September 30, 2009, noninterest income was $24.9 million. Excluding the first quarter gain on the SFSB transaction of $20.3 million, noninterest income would have been $4.7 million, compared with $1.1 million during the same period of 2008. Service charges on deposit accounts aggregated $1.9 million compared with $696,000 for the same period in 2008. This increase of $1.2 million or 167.67% was the result of no banking operations reported for the first five months of 2008 and an increase in the number of deposit accounts subject to fees and charges through September 30, 2009. Likewise, other noninterest income equaled $1.3 million for the nine months ended September 30, 2009, versus $357,000 for the same period in 2008. The Company has recorded net securities gains of $905,000 and gains on the sale of other real estate of $563,000 through the first nine months of 2009 versus none in the same period in 2008.

Noninterest Expenses

For the three month period ended September 30, 2009, noninterest expenses were $9.9 million compared with $4.7 million for the same period in 2008. Salaries and employee benefits were $4.8 million and represented 48.70% of all noninterest expenses for the quarter. Salaries and wages increased $2.5 million or 103.79% from the same quarter in 2008. The increases in salaries and wages are the direct result of increased staffing levels from the prior year period related to the acquisitions of TCB and SFSB coupled with corporate staff hires for positions required in a now significantly larger financial institution.

Other overhead costs included other operating expenses of $1.8 million, amortization of intangibles of $565,000, occupancy expenses of $752,000, equipment expense of $436,000, data processing fees of $743,000, legal fees of $217,000, and other professional fees of $185,000. FDIC assessments for the quarter equaled $436,000.

For the nine month period ended September 30, 2009, noninterest expenses were $53.8 million, which includes the aforementioned $24.0 million goodwill impairment charge. Salaries and employee benefits were $14.3 million and represented 47.95% of overhead exclusive of the goodwill impairment charge. Throughout the first nine months of 2009, the Company hired additional personnel in

 

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key functional areas. Other overhead costs included other operating expenses of $5.1 million, amortization of intangibles of $1.7 million, occupancy expenses of $1.9 million, equipment expense of $1.2 million, data processing fees of $2.2 million, professional fees of $1.3 million, and legal fees of $772,000.

Income Taxes

An income tax benefit of $1.5 million was recorded for the three months ended September 30, 2009, and there was an income tax expense of $3.4 million for the nine months ended September 30, 2009. Income tax expenses were $234,000 and $392,000 for the same respective periods in 2008. This substantial difference is directly attributable to the goodwill impairment charge recorded during the second quarter of 2009, as this impairment charge did not reduce taxable income. The Company had a deferred tax liability at September 30, 2009.

Supplemental Results of Operations Information on Predecessors

The following information represents a discussion and analysis of the results of operations of each of the Company’s predecessors for the five months ended May 31, 2008.

TransCommunity Financial Corporation (TFC)

Results of Operations

For the five months ended May 31, 2008, net losses were $3.9 million or $(.85) per share. The loss incurred was primarily the result of one-time noninterest expenses related to the May 31, 2008 acquisition by the Company as well as an increase in the provision for loan losses.

Net interest income was $3.8 million for the five months ended May 31, 2008. Net interest margin was 3.86%

For the five months ended May 31, 2008, the Company’s provision for loan losses was $1.3 million. The increase in loan loss reserves was due to a combination of the provisions required to support loan growth, plus downgraded loans and seasoning of the loan portfolio.

For the five months ended May 31, 2008, noninterest income was $429,000.

For the five months ended May 31, 2008, noninterest expenses were $8.2 million. Salaries and employee benefits were $3.7 million and represented 45.06% of all noninterest expenses for the period. Additionally, the Company incurred occupancy expenses of $318,000, equipment expense of $295,000, and other noninterest expenses of $3.9 million, which were comprised of data processing fees of $1.9 million, professional fees of $1.0 million, legal and accounting fees of $260,000, and other expenses totaling $702,000.

One-time noninterest expenses related to the May 31, 2008 acquisition by the Company included $1.3 million in salaries and benefits related to severance and bonuses, $1.7 million in data processing resulting from the termination of a data processing contract and $1.0 million in professional fees.

An income tax benefit of $1.5 million was recorded for the five months ended May 31, 2008.

BOE Financial Services of Virginia, Inc. (BOE)

Results of Operations

For the five months ended May 31, 2008, net losses were $188,000 or $(0.15) per share. The loss incurred was primarily the result of one-time noninterest expenses related to the May 31, 2008 acquisition by the Company.

Net interest income was $4.0 million for the five months ended May 31, 2008. Net interest margin was 3.62%

For the five months ended May 31, 2008, the Company’s provision for loan losses was $200,000. Increases were made to the loan loss reserve due to general seasoning of the portfolio.

For the five months ended May 31, 2008, noninterest income was $854,000. Comprising this amount, service charge income was $464,000 and other income was $390,000. Included in other income for the five months ended May 31, 2008 is a $92,000 loss on sale of other real estate.

 

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For the five months ended May 31, 2008, noninterest expenses were $4.9 million. Salaries and employee benefits were $2.5 million and represented 51.07% of all noninterest expenses for the period. Additionally the Company incurred data processing fees of $394,000, legal fees of $306,000, equipment expense of $286,000, professional fees of $258,000, and occupancy expenses of $216,000.

One-time noninterest expenses related to the May 31, 2008 acquisition by the Company included $375,000 in salaries and benefits, $160,000 in professional fees, $84,000 in legal fees, $54,000 in equipment expenses, and $167,000 in data processing expenses.

An income tax benefit of $10,000 was recorded for the five months ended May 31, 2008.

Asset Quality

The allowance for loan losses represents management’s estimate of the amount appropriate to provide for probable losses inherent in the non-FDIC covered loan portfolio. Probable losses in the covered loans are incorporated in the fair market value analysis for the covered loans, and accordingly impact the covered loans balance and the FDIC indemnification asset balance, and not the allowance for loan losses. As such, the following asset quality information separates the covered loans from the non covered loans.

Total Loans Excluding Covered Loans

The Company’s asset quality is continually monitored, and the Company’s management has established an allowance for loan losses that it believes is appropriate for the risk of loss inherent in the loan portfolio. Among other factors, management considers the Company’s historical loss experience, the size and composition of the loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits and current and anticipated economic conditions. There are additional risks of future loan losses, which cannot be precisely quantified nor attributed to particular loans or classes of loans. Because those risks include general economic trends, as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The allowance is also subject to regulatory examinations and determination as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and size of the allowance in comparison to peer companies identified by regulatory agencies.

The Company maintains a list of loans that have potential weaknesses that may need special attention. This nonperforming loan list is used to monitor such loans and is used in the determination of the appropriateness of the Company’s allowance for loan losses. At September 30, 2009, nonperforming assets, excluding FDIC covered assets, totaled $23.2 million compared with $25.9 million and $5.2 million at June 30, 2009, and December 31, 2008, respectively. The $20.7 million increase in nonperforming loans during the first two quarters of 2009, was primarily attributable to eight credit relationships aggregating approximately $18.6 million being placed in nonaccrual status. These credit relationships accounted for nearly 90% of the increase during the first two quarter of 2009 and ranged in size from $7.2 million to $0.8 million. These borrowers are commercial/ residential land developers and their loans are secured by real estate. As of September 30, 2009, credit exposure for these eight borrowers was $17.2 million, with approximately $5.0 million allowance allocated. The remaining $2.1 million increase in nonperforming assets during the first two quarters of 2009, were all smaller credit relationships. These creditors were primarily commercial/residential land developers with loans secured by real estate. During the third quarter of 2009, nonperforming assets declined $2.7 million. Loan charge-offs represented $1.4 million of this decline, and the remaining portion was attributable to the disposition of other real estate owned (OREO) during the quarter. Excluding FDIC covered loans, net charge-offs were $1.2 million and $2.0 million for the three and nine months ended September 30, 2009, respectively.

At September 30, 2009, nonapccrual loans, excluding FDIC covered assets, were $20.6 million or 3.61% of total loans. OREO equaled $1.2 million, excluding OREO in the Maryland operations.

Nationally, industry concerns over asset quality have increased due in large part to issues related to subprime mortgage lending, declining real estate activity and general economic concerns. While the Company has experienced reduced residential real estate activity, the markets in which the Company operates indicate a weakened economic condition. While the Company incurred appropriate provisions for loan losses and thus an adequate level of allowance for loan losses, there has been continued deterioration in the quality of the loan portfolio. Residential loan demand has moderated somewhat, but the Company is still experiencing continued loan demand, particularly in commercial real estate. Management will continue to monitor delinquencies, risk rating changes, charge-offs, market trends and other indicators of risk in the Company’s portfolio, particularly those tied to residential real estate, and adjust the allowance for loan losses accordingly.

 

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The following table sets forth selected asset quality data, excluding FDIC covered assets, and ratios for the dates indicated:

 

(dollars in thousands)		September 30, 2009				December 31, 2008
Nonaccrual loans		$	20,572			$	4,534
Loans past due over 90 days			1,462				397
Other real estate owned			1,175				223
Total nonperforming assets		$	23,209			$	5,154
Balances
Allowance for loan losses		$	16,211			$	6,939
Average loans during quarter, net of unearned income		$	559,547			$	511,042
Loans, net of unearned income		$	569,452			$	523,298
Ratios
Allowance for loan losses to loans			2.85	%			1.33	%
Allowance for loan losses to nonperforming assets			69.85	%			134.63	%
Nonperforming assets to loans & other real estate			4.07	%			0.98	%
Net charge-offs for quarter to average loans, annualized			0.86	%			0.32	%

 

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A further breakout of nonaccrual loans, excluding covered loans, at September 30, 2009 and December 31, 2008 is below:

 

(Dollars in Thousands)		September 30, 2009												December 31, 2008
		Amount of Non Accrual				Non Covered Loans				Percentage of Non Covered Loans				Amount of Non Accrual				Non Covered Loans				Percentage of Non Covered Loans
Open End 1-4 Family Loans		$	—			$	20,075				0.00	%		$	276			$	30,323				0.91	%
1-4 Family First Liens			2,020				108,380				1.86	%			318				99,284				0.32	%
Total residential 1-4 family			2,020				128,455				1.57	%			594				129,607				0.46	%
Owner occupied nonfarm nonresidential			—				43,423				0.00	%			200				63,218				0.32	%
Non owner occupied nonfarm nonresidential			4,413				111,768				3.95	%			582				93,872				0.62	%
Total commercial			4,413				155,191				2.84	%			782				157,090				0.50	%
1-4 Family Construction			855				50,842				1.68	%			1,194				36,277				3.29	%
Other construction and land dev.			12,687				131,902				9.62	%			461				103,238				0.45	%
Total construction			13,542				182,744				7.41	%			1,655				139,515				1.19	%
Second mortgages			199				14,051				1.42	%			497				15,599				3.19	%
Multifamily			—				10,757				0.00	%			—				9,370				0.00	%
Agriculture			—				3,907				0.00	%			433				5,143				8.42	%
Total real estate loans			20,174				495,105				4.07	%			3,961				456,324				0.87	%
Agriculture loans			—				1,407				0.00	%			—				988				0.00	%
Commercial and industrial loans			194				45,348				0.43	%			224				44,332				0.51	%
Total commercial loans			194				46,755				0.41	%			224				45,320				0.49	%
Total revolving credit and other consumer			204				15,977				1.28	%			25				14,457				0.17	%
All other loans			—				11,700				0.00	%			324				7,005				4.63	%
Gross loans		$	20,572			$	569,537				3.61	%		$	4,534			$	523,106				0.87	%

Total Delinquencies

The following table presents a summary of non covered loans, greater than 30 days and less than 90 days past due at the dates indicated (dollars in thousands):

 

		September 30, 2009				December 31, 2008
30-89 Days Past Due		$	9,178			$	15,191
% of Non Covered Loans			1.61	%			2.90	%

Covered Loans

Covered loans are not classified as nonperforming assets at September 30, 2009 as the loans are accounted for on a pooled basis and the pools are considered to be performing. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, is being recognized on all purchased loans. There was no allowance for loan losses recorded on covered loans at September 30, 2009.

As of January 1, 2009, there were no covered loans. Covered assets that would normally be considered non-performing except for the accounting requirements regarding purchased impaired loans and other real estate owned covered by the FDIC shared-loss agreements at September 30, 2009 are as follows:

 

(dollars in thousands)
		September 30, 2009
Nonaccrual covered loans(1)		$	66,020
Fair value adjustment			(32,872	)
Nonaccrual covered loans at fair value			33,148
Other real estate owned (OREO) - covered			11,105
Total nonperforming covered assets		$	44,253

 

(1)

Amount is based on contractual book value. Contractual book value of total covered loans is $262.4 million at September 30, 2009. In accordance with ASC 310, covered loans are recorded at fair market value of $166.1 million at September 30, 2009.

 

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Impairments

See Note 11 to the unaudited consolidated financial statements for information related to the allowance for loan losses. At September 30, 2009, total impaired loans equaled $54.5 million, excluding FDIC covered assets.

Impaired loans, by definition, are loans where management believes that it is more likely than not that the borrower will not be able to fully meet its contractual obligations, including all principal and interest payments. Under our current internal loan grading system, this would include all loans adversely classified “substandard” or worse. These impaired loans have been determined through analysis, appraisals, or other methods used by management.

During the recent review of impaired loans, it was determined that loans risk graded as “watch/special mention” were included along with the listing of “substandard” or “doubtful” loans reported as impaired loans. “Watch/special mention” loans, by definition within the Bank’s credit policy, are loans where management expects to be repaid under the contractual terms. Therefore, “watch/special mention” loans do not meet the definition of impaired loans.

In the original Form 10-Qs filed by the Company for 2009, management included all “watch/special mention” loans in addition to those deemed “substandard” and “doubtful” as impaired loans. Those loans internally rated “watch” or “special mention”, by definition within the Bank’s credit policy, are loans that are expected to be repaid under the contractual terms and are not considered impaired. As a result, loans previously classified as impaired would have more accurately been reflected as detailed in the following table.

As previously reported:

 

(dollars in thousands)
		September 30, 2009
Impaired with a valuation allowance		$	26,776
Impaired without a valuation allowance			96,684
Total impaired loans		$	123,460

Under the Company’s new loan grading system:

 

(dollars in thousands)
		September 30, 2009
Impaired with a valuation allowance		$	26,776
Impaired without a valuation allowance			27,728
Total impaired loans		$	54,504

The Company has restated its reporting of impaired loans in this report, and intends to consistently apply its internal loan risk rating system under the prescribed format in future reporting periods. The Company has determined that this application will not have, or would have had, a material impact on its financial statements.

Capital Requirements

The determination of capital adequacy depends upon a number of factors, such as asset quality, liquidity, earnings, growth trends and economic conditions. The Company seeks to maintain a strong capital base to support its growth and expansion plans, provide stability to current operations and promote public confidence in the Company.

The federal banking regulators have defined three tests for assessing the capital strength and adequacy of banks, based on two definitions of capital. “Tier 1 Capital” is defined as a combination of common and qualifying preferred stockholders’ equity less goodwill. “Tier 2 Capital” is defined as qualifying subordinated debt and a portion of the allowance for loan losses. “Total Capital” is defined as Tier 1 Capital plus Tier 2 Capital.

 

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Three risk-based capital ratios are computed using the above capital definitions, total assets and risk-weighted assets and are measured against regulatory minimums to ascertain adequacy. All assets and off-balance sheet risk items are grouped into categories according to degree of risk and assigned a risk-weighting and the resulting total is risk-weighted assets. “Tier 1 Risk-based Capital” is Tier 1 Capital divided by risk-weighted assets. “Total Risk-based Capital” is Total Capital divided by risk-weighted assets. The Leverage ratio is Tier 1 Capital divided by total average assets.

At September 30, 2009, the Company’s ratio of total capital to risk-weighted assets was 18.49%. The ratio of Tier 1 capital to risk-weighted assets was 17.28%, and the leverage ratio (Tier 1 capital to average adjusted total assets) was 9.31%. All three ratios exceed capital adequacy guidelines outlined by its regulator, and the Company is considered “well-capitalized”. At December 31, 2008, the Company’s ratio of total capital to risk-weighted assets was 20.00%. The ratio of Tier 1 Capital to risk-weighted assets was 18.92%, and the leverage ratio (Tier 1 capital to average adjusted total assets) was 12.54%. The Company has trust preferred subordinated debt that qualifies as regulatory capital. This trust preferred debt has a 30-year maturity with a 5-year call option, and was issued at a rate of three month LIBOR plus 3.00%, and was priced at 3.60% in the third quarter of 2009.

Liquidity

Liquidity represents the Company’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, and certain investment securities. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customer’s credit needs.

Off-Balance Sheet Arrangements and Contractual Obligations

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its clients and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk. The ongoing monitoring and management of interest rate risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (“ALCO”) of the Bank. In this capacity, ALCO develops guidelines and strategies that govern the Company’s asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over various periods, it also employs additional tools to monitor potential longer-term interest rate risk.

The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheet. The simulation model is prepared and updated monthly. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given a 200 basis point upward shift and a 200 basis point downward shift in interest rates. A parallel shift in rates over a 12-month period is assumed. The following table represents the change to net interest income given interest rate shocks up and down 100 and 200 basis points at September 30, 2009:

 

		Change In Net Interest Income
(dollars in thousands)		%				$
Interest Rate Shock:
+200 basis points			-2.74	%			(1,186	)
+100 basis points			-1.95	%			(842	)
No change			0.00	%			—
-100 basis points			3.31	%			1,431
-200 basis points			7.69	%			3,325

 

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At September 30, 2009, the Company’s interest rate risk model indicated that, in a rising rate environment of 200 basis points over a 12 month period, net interest income could decrease by 2.74%. For the same time period, the interest rate risk model indicated that in a declining rate environment of 200 basis points, net interest income could increase by 7.69%. While these percentages are subjective based upon assumptions used within the model, management believes the balance sheet is appropriately balanced with acceptable risk to changes in interest rates.

The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels such as yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to, or in anticipation of, changes in interest rates.

 

Item 4.

Controls and Procedures

Disclosure Controls and Procedures

At the end of the period covered by this Form 10-Q, the Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, conducted an evaluation of the Company’s disclosure controls and procedures. As defined under Section 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management to allow timely decisions regarding required disclosures.

Based on this evaluation, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures were not effective to ensure that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder. Two issues that these officers have identified in making this conclusion at the end of the third quarter of 2009 are the determination that the Company’s financial and accounting department has not effectively documented and assessed accounting issues related to non-routine transactions, such as mergers and non-recurring items that the Company has had to evaluate since May 2008, and the determination that the Company’s financial and accounting department is understaffed. This conclusion is the same conclusion that these officers made as of June 30, 2009, as disclosed in its Quarterly Report on Form 10-Q for the period ended June 30, 2009.

Additional information with respect to these issues is included in the discussion below.

 

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Internal Control over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles. In the Annual Report on Form 10-K for the year ended December 31, 2008, management’s assessment of the effectiveness of the Company’s internal control over financial reporting cited a material weakness regarding the accounting for non-routine transactions, as described below. While management is not required to re-assess the effectiveness of internal control over financial reporting during the fiscal year, the Company has concluded that this material weakness continues to exist as of September 30, 2009. Specifically, the Company’s financial and accounting department has lacked sufficient resources and expertise to properly account for certain non-routine transactions, the Company’s policies and procedures have not provided for timely review of significant non-routine transactions and related accounting entries and the Company has not maintained sufficient documentation related to the application of GAAP to significant non-routine transactions.

A material weakness is a significant deficiency (as defined in the Public Company Accounting Oversight Board’s Auditing Standard No. 5), or combination of deficiencies, such that there is a reasonable possibility that a material misstatement in the annual or interim financial statements will not be prevented or detected on a timely basis by employees in the normal course of their work. The Company believes that a material weakness regarding the accounting for non-routine transactions remains as of September 30, 2009, in light of the uncertainty with respect to accounting issues related to the Company’s accounting for subsidiary costs that were applied in the Company’s mergers with TFC and BOE, the public correction of the Company’s preliminary earnings release for the second quarter of 2009 to make certain adjustments relating to the tax effect of its goodwill impairment charge, and the need to amend past periodic reports to include financial statements and related information with respect to each of the Company’s predecessors (TFC and BOE) and otherwise enhance disclosure relating to goodwill and intangible assets, fair value measurements, FDIC-covered assets and asset quality in response to a comment letter from the staff of the Commission.

As of the date of the filing of this report, the Company has not identified any specific issues that could result in a restatement of past financial information, notwithstanding the amended filings that the Company will file in response to the Commission’s comments to include additional and enhanced financial disclosures, as described above. The Company acknowledges, however, that its financial and accounting documentation for non-routine transactions is less than satisfactory for the criteria required for the framework for effective internal control over financial reporting.

In addition, the Company’s financial and accounting department is currently understaffed for the responsibilities that it has had in recent fiscal quarters. While the Company has a chief financial officer and a chief accounting officer, the Bank has not had a controller since April 2009. The Company’s financial and accounting department has also had to evaluate numerous non-routine accounting issues in addition to focusing on the day-to-day fiscal operations of the Company and periodic filings with the Commission. For example, the Company acquired the operations of SFSB in January 2009, and the on-going consolidation of those operations and analysis of unprecedented accounting issues relating to shared-loss agreements with the FDIC have strained the resources presently available at the Company.

While acknowledging the existence of a material weakness and the specific issues associated with it, the Company believes that the Company’s financial and accounting department performs its responsibilities with respect to the completion of accurate financial information in its periodic filings with the Commission.

In addition, the Company, formerly a special purpose acquisition company, and its wholly-owned operating subsidiary, Essex Bank (the “Bank”), have grown substantially over the past 18 months. In May 2008, the Company merged with each of BOE, the holding company for the Bank, and TFC, the holding company for TransCommunity Bank, and, in July 2008, TransCommunity Bank merged into the Bank. In November 2008, the Bank acquired certain assets and assumed all deposit liabilities of TCB and, in January 2009, the Bank acquired certain assets and assumed all deposit liabilities of SFSB. This significant growth has put considerable strain on the Company’s organizational structure and the effectiveness of risk management programs that are appropriate for the various functions of an organization of the Company’s size and complexity. Furthermore, this growth has strained the Company’s control structure, including the structure that supports the effective application of policies and the execution of procedures within the operation of financial reporting controls.

The Company believes that it has identified the risk management and related issues that it needs to address, including the items described above that have impacted the effectiveness of the Company’s internal control over financial reporting.

Remediation Steps to Address Material Weakness

To address the issues described above, the Company continues to take appropriate remediation steps. The Company is evaluating its financial accounting staff levels and expertise and is implementing appropriate oversight and review procedures. The Company also has put in place internal remediation plans that address concerns that have arisen in maintaining the effectiveness of the Company’s risk management programs.

 

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The Company engaged a public accounting firm to serve as its internal auditing firm beginning in April 2009. The Company created a new chief internal auditor position and hired in June 2009 a chief internal auditor who reports directly to the Company’s Audit Committee, and the Company continues to recruit actively a bank controller. The Company has also hired additional key members of management, including a chief administrative officer, a chief credit officer and a general counsel, during the first six months of 2009, and these individuals are actively assisting the Company in reviewing, assessing and implementing, as appropriate, numerous policies and procedures applicable to the Company and its operations.

During the third quarter of 2009, the Company engaged an independent consulting firm to support the Company in its assessment of the Company’s quarterly post-closing process, its assessment of the internal control processes in the Company’s financial and accounting department to ensure that all key controls are identified and that the controls and process are appropriately documented and provide qualified resources to support the Company’s chief financial officer and chief accounting officer. In addition, the Company engaged an independent accounting firm to support the Company with the accounting for the loan portfolio in its Maryland market subject to the FDIC shared-loss agreements.

Also during the third quarter, under the oversight of its Board of Directors and its various committees, the Company established comprehensive internal remediation plans for issues that it has identified with respect to its internal audit and Sarbanes-Oxley controls, and each plan has detailed corrective actions, identifies members of management as responsible parties and sets completion dates for addressing issues. These plans include the review, adoption and implementation of numerous formal policies and procedures appropriate for controls of an organization of the Company’s size and complexity. The Company believes that these actions have positively affected the Company’s internal control over financial reporting in the limited time that they have been implemented and that they will continue to positively affect such controls in the future.

The Company believes that it is taking all of the necessary corrective actions to the material weaknesses and other issues described above. As of the date of this filing, the Company anticipates that it will complete all of its material corrective actions by March 31, 2010.

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.

 

Item 1A.

Risk Factors

The Company’s operations are subject to many risks that could adversely affect its future financial condition and performance and, therefore, the market value of its common stock. See Exhibit 99.1 for information on risk factors that could affect the Company’s future financial condition and performance, and such information is incorporated by reference into this Item 1A.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3.

Defaults upon Senior Securities

None.

 

Item 4.

Submission of Matters to a Vote of Security Holders

None.

 

Item 5.

Other Information

None

 

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Item 6.

Exhibits

 

Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification for Chief Executive Officer*
31.2		Rule 13a-14(a)/15d-14(a) Certification for Chief Financial Officer*
31.3		Rule 13a-14(a)/15d-14(a) Certification for Chief Executive Officer (Amendment No. 1)*
31.4		Rule 13a-14(a)/15d-14(a) Certification for Chief Financial Officer (Amendment No. 1)*
31.5		Rule 13a-14(a)/15d-14(a) Certification for Chief Executive Officer (Amendment No. 2)**
31.6		Rule 13a-14(a)/15d-14(a) Certification for Chief Financial Officer (Amendment No. 2)**
32.1		Section 1350 Certifications**
99.1		Risk Factors*

 

 

*	Previously filed.

**  Filed

herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: March 3, 2011

 

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